Value Factor

The value factor captures the tendency of cheap stocks, measured by ratios such as price to book or price to earnings, to outperform expensive stocks over long periods. It is the oldest systematic investment idea, rooted in the work of Benjamin Graham in the 1930s, and one of the most studied factors in finance. Value has delivered strong long run results historically but has also suffered some of the longest and most painful drawdowns of any factor, testing the patience of its followers.

Measuring value#

The evidence#

• Fama and French (1992) found that book to market had strong explanatory power for US stock returns from 1963 to 1990, with cheap stocks outperforming expensive ones.
• Value premiums have been documented across many countries and in other asset classes, such as country equity indices, currencies (relative purchasing power) and commodities, by Asness, Moskowitz and Pedersen (2013).
• The HML factor (high minus low book to market) in Kenneth French's data earned a positive average return of several percent a year over the long run, with large variation.

Why might value work?#

The long value drawdown#

Improving value signals#

• Use multiple measures rather than book to market alone.
• Adjust for intangibles: capitalise R&D and brand spending to improve book value for modern companies. See Goodwill and Intangible Assets.
• Combine with quality: avoid "value traps", cheap stocks that are cheap for good reasons. See Quality and Profitability Factors.
• Combine with momentum: value and momentum are negatively correlated, so combining them smooths returns. See Combining Signals.
• Industry neutral ranking: compare companies with peers rather than across all sectors.

Value traps#

A value trap is a stock that looks cheap but keeps falling because its business is deteriorating. Examples include companies in structural decline or facing disruption. Quality filters, earnings revisions and momentum can help avoid them. See Guidance and Earnings Revisions.

Implementing value#

Value strategies usually have moderate turnover, which keeps costs manageable. See Signal Turnover, Breadth and Neutralization.

Frequently asked questions#

What is the value factor?#

The tendency of cheap stocks, measured by ratios like book to market or earnings yield, to outperform expensive stocks over long periods.

Why did value stocks underperform in the 2010s?#

Explanations include falling interest rates favouring growth stocks, the rising importance of intangible assets missed by book value and crowding into growth.

What is a value trap?#

A stock that appears cheap but keeps falling because its business is deteriorating, which quality and momentum filters can help avoid.

Next, learn the factor that buys winners in Momentum Factor.