Thus, a value orientation has been a major advantage over these past 50+ years, and it has been evident across most rolling five-year periods, as you can see here.

We believe that this value advantage is caused by powerful human biases that impact investors’ evaluations of companies’ future prospects. It is well-documented that people fear losses more than they value gains. It is also well-documented that, when people make decisions, they have a tendency to give more weight to recent experiences than to experiences from the more distant past.

Perhaps this is why, when investors identify exciting companies, they seem to imagine them growing to the sky. We believe this is why investors perpetually overpay for growth companies, making them (as a group) poor investments. Likewise, with companies facing some sort of difficulty, investors seem to assume that because things have gotten worse, they can only get worse. Investors appear to extrapolate current difficulties to such extremes that value stocks became priced low enough to provide (as a group) better-than-market returns.

These investor tendencies seem systemic and provide a good model for understanding the cause of the historical value advantage.

Today, however, value strategies seem stuck in a rut, providing their weakest returns relative to the market in quite some time. Have investors evolved such that they have overcome the biases on which the value advantage depends?

That seems unlikely. If investors’ tendencies to take equity prices to extremes were in decline, we would expect to see tighter than normal spreads in how companies are valued. That is, we would expect to see growth investors being a little more careful with price paid, and we would also expect struggling companies to no longer sell at the very large discounts that enabled good value returns in the past. But the opposite is occurring. Recent valuation spreads appear wider than at any point in the past 50 years, except for during the peak of the dot-com bubble. [2]

Instead of the value advantage being in decay, we believe we are simply in the midst of one of those times required for the value advantage to persist over the long term. Look at the cycles between value and growth investing, which we have described in great detail in prior letters. There have been six distinct periods since WWII when growth outperformed value on a trailing five-year compounded return basis, and we are currently in one of these periods. During each of these times, value investing appeared dead.