Blog - Investing Notes

Blog Synthesis: The Value Premium

Does value investing really work? If so, why, and how can traders exploit it? Here is a listing of past blog entries related to the value premium:

Measuring the Value Premium with Style-based ETFs ...a simple test with available data (about seven years) does not support a belief that investors can reliably capture a substantial value premium via style-based ETFs.

Value Premium and Size Effect in Australia ...evidence indicates that the Australian stock market offers a strong value premium and a weak size effect.

The Behavioral Asset Pricing Model ...investors on the whole base their (mis)perceptions of risk and return on feelings rather than rational pricing analysis. Contrarians may be able to exploit the underpricing of "despised" stocks by focusing on small value.

Fama and French Dissect Anomalies ...some anomalies are stronger and more consistent than others. Momentum appears to be the strongest and most consistent.

Combined Value-Momentum Tactical Asset Class Allocation ...value and momentum investing may work across a broad range of asset classes, and the two effects are independent enough that combining them may yield incremental outperformance.

Growth Versus Value and the Yield Curve ...limited analyses do not support the hypothesis that growth (value) stocks systematically outperform when the T-note/T-bill yield spread shrinks (grows).

Growth Versus Value and Interest Rates ...limited analyses offer little support for Louis Navellier's hypothesis that growth (value) stocks systematically outperform when interest rates are rising (falling).

Australian Stock Market Anomalies ...the Australian stock market offers several historical anomalies, most notably size and negative earnings-to-price, that investors/traders may be able to exploit.

Multi-year Reversals for Past Winners and Losers ...the persistent and robust multi-year reversal of returns observed among UK stocks supports the view that investors overreact to price trends of the past few years, driving good (poor) performers too high (low).

Using Firm Productivity Measures to Enhance Stock Returns ...combining a value investing style with a screen for high return on invested capital (productivity) may yield very high-performing portfolios.

Value Versus Growth Among Large European Firms ...value beats growth among large European stocks during 2002-2006. Value stocks with the highest return on invested capital lead this outperformance.

Testing the Value Premium Down Under ...there is a highly significant value premium among Australian stocks, and the book-to-market ratio is the best way to capture that premium. A size effect exists only among the very smallest stocks.

Wet Beats Dry for Portfolio Growth? ...the most liquid stocks on average outperform, and this liquidity effect may be central to the value premium.

The Value Premium Looking Forward ...investors have expected a fairly stable value premium of about 6% per year over the past 60 years, derived mostly from growth in dividends.

Testing Benjamin Graham Out of Sample ...Benjamin Graham-style value investing still works but is more difficult to execute than in the past because severe undervaluation has become rarer.

Enhancing the Value Premium Via P/E Analysis ...an investment strategy based on extreme P/Es calculated with an extended earnings history and concentrated by stripping out market, industry and style factors offers extreme returns.

Institutional Herding and the Value Premium ...institutional herding on hope and fear drives overvaluation (undervaluation) of growth (value) stocks, leading to their future reversals of fortune.

Quantifying and Exploiting Long (Bull and Bear) Trends ...portfolio management based on statistically reliable characterization of the long-term trend of the stock market offers an economically significant advantage over approaches that ignore the long-term trend.

Combining Value Indicators with Stock Repurchasing ...an exchange traded fund that focuses on value stocks with repurchase activity would be an attractive long-term investment vehicle.

Emergent Size-Value Patterns of Noise? ...the value premium and the size effect are real manifestations of emergent patterns of noise across large groups of stocks.

Sell Risk to Growth Investors and Buy It from Value Investors? ...value investors are generally risk avoiders, and growth investors are typically risk seekers. Buying risk from one group and selling it to the other may be profitable.

Do Mutual Funds That Practice Behavioral Finance Principles Outperform? ...investing based on the principles of behavioral finance is indistinguishable from value investing, producing similar raw excess returns.

Buying and Selling Noise? ...small capitalization value investing works by systematically buying negative noise and selling positive noise.

Dynamics of Size and Value Investing ...as a corollary to mean reversion of firm profitability, asymmetries in small-big and value-growth stock migrations drive the size effect and the value premium.

A Short-term VIX Trading Strategy That Works? ...VIX signals are useful for short-term switching between small-capitalization and large-capitalization stock indexes, especially when VIX is historically high.

Separating Cash Flow and Discount Rate Contributions to Returns ...separating stock returns into those driven by changes in cash flow and those driven by changes in the discount rate helps explain the size effect and the value premium.

Why Highly Volatile Stocks Tend to Underperform ...the idiosyncratic volatility (beta) premium is closely related to the value premium, with low volatility and high value stocks tending to outperform. Insensitivity to discount rate (inflation, interest rate...) shocks is the common underlying factor.

Capturing the Value Premium by Avoiding Institutional Ownership ...capturing the value premium means focusing on stocks with the lowest institutional ownership.

Combining Momentum and Value Styles ...investors can enhance returns by combining value and momentum styles, leaning toward momentum when the yield curve is normal and value when the yield curve is inverted.

(Not) Capturing the Elusive Value Premium ...the bid-ask spread, transaction costs and the price impact of trading make the value premium in small-capitalization stocks hard to capture. The prey is generally too elusive for mutual funds and indices.

Challenging the Value Premium ...the empirical foundation for value investing may not be as sound as generally thought.

Value Versus Growth When the Economy Is Bad ...value beats growth as a rational reward for the relatively higher risk inherent in the fundamental performance of value companies during recessions.

January Effect Alive and Well? ...history still favors small-capitalization value stocks in January.

Book (Value) It? ...because mean reversion of price-to-book ratios outpaces reinvestment of earnings, value stocks outperform growth stocks.

Value Versus Growth (Again): The Winner Is... ...value beats growth overall and during expansions. During recessions, value and growth tie.

Piotroski's Efficient Value Investing ...careful screening of value stocks using accounting fundamentals can significantly enhance returns.

In summary, recent research indicates that value investing works for individuals when focused on the stocks of small, relatively obscure companies. However, the relative illiquidity of such stocks presents a trading challenge.