Mirror, mirror, on the wall – which is the fairest of them all?

Recent commentary (to include a recent Barron’s article) seems to suggest that value is dead and may never come back. Of course, most of these comments revolve around the price-to-book valuation metric, which, as the Barron’s article points out, might have some issues:

But there’s a problem with price/book: today’s economy. Price/book, perhaps the most conventional measure of value, evaluates stock prices based on a company’s book value—the worth of all tangible assets but no intangible ones…Today’s service economy is filled with companies whose biggest assets are their brands, intellectual property, or customer loyalty, which don’t show up on the balance sheet.

But as Wes highlighted not that long ago in a WSJ piece, determining if value investing is dead, really hinges on how one measures “value investing.”

In this piece, we look at the performance of various value investing screens from 2000 to 2018 across the globe to garner some more insight on how value investing has faired in recent memory. The results suggest a mixed view on value. There is no conclusive evidence that value is dead, but there is also no clear case that value has done well.

Valuation Horse Race Methodology

Systematic value investors face a lot of options when deciding which value metric they should utilize when constructing their portfolios. Historically, investors have focused on the price-to-book ratio, which is still the preferred metric in some sectors, e.g. REIT specialists in Europe and Asia continue to focus on premium and discount to book values as it is a very intuitive measure for identifying value in the real estate sector. However, in most sectors investors tend to focus on earnings or cashflow-based metrics. In this short research note, we will compare different value metrics across the globe and evaluate utilizing a multi-metric approach. Wes and Jack have done a similar analysis for the US market over a 40-year period, which can be contrasted with the results below.

We focus on value portfolios in the US, Europe and Japan and the following four valuation metrics: price-to-book (P / B), price-to-earnings (P / E), price-to-free cashflow (P / FCF) and enterprise value-to-EBITDA (EV / EBITDA). The portfolios are constructed by taking the top 10% of the stock universes and are rebalanced monthly. Only stocks with market capitalizations of larger than $1 billion are considered and 10 basis points of costs per transaction are included.

US Value Portfolios: Metric Comparison

The chart below shows the comparison of different metrics for value portfolios in the US for the period from 2000 to 2018. We can observe that all portfolios outperformed the market over that time period, which can be explained by the period from 2000 to 2003, where the Tech bubble imploded and cheap stocks significantly outperformed the index.

The analysis highlights that the price-to-book portfolio generated the lowest performance, which likely indicates that in the US this metric has been inferior for identifying cheap companies compared to others. Modern finance focuses more on earnings and cashflow than book values, which rarely reflect the intrinsic value of company, e.g. technology companies tend to have few tangible assets. The multi-metric portfolio, which ranks stocks for all four metrics simultaneously, generated the strongest performance.

It is worth highlighting that the valuation metrics lead to different portfolios from a sector perspective. For example, EBITDA (earnings before interest, depreciation and amortization) is not a meaningful measure for banks, as their major source of income is interest, which means they are excluded from the EV / EBITDA portfolio (other financial companies, like asset managers, which have fee income are included).