A Value Stock Comeback Is Not Inevitable
The past decade has not been a favorable era for proponents of value investing, often associated with Warren Buffett’s methodology. From 2014 to 2024, the S&P 500 Value Index—comprising stocks perceived as underpriced based on financial ratios—delivered an annualized return of 9.98%. In stark contrast, the S&P 500 Growth Index achieved a robust 15.26%. The disparity widened in 2024, when value investors saw meager gains while companies like Nvidia posted astronomical returns, with a staggering 171.25% total return.
Value-investing enthusiasts often counter such trends by invoking the principle of mean reversion, which posits that market excesses eventually correct. They maintain that investors adhering to the discipline of buying “dollars for fifty cents” will ultimately prevail. However, the inevitability of this reversal merits scrutiny. Could the dominance of growth stocks reflect not a temporary mania, but a structural transformation in the economy?
The alternative thesis is that the US is undergoing a New Industrial Revolution, where technological innovation sustains higher earnings growth, benefiting growth stocks disproportionately. This perspective challenges the assumption that value investing is bound for a resurgence. Fortunately, investors need not rely on speculation. By examining historical data, we can better assess the likelihood of future scenarios.
Historical Trends in Performance
The relative performance of growth (S&P500 Growth Index) and value stocks (S&P500 Value Index) over the past three decades undermines the argument for mean reversion. Growth’s margin of outperformance has not diminished but has instead expanded (see Exhibit 1). This raises a critical question: if mean reversion is inevitable, when will it begin?
Exhibit 1 – S&P500 Value vs Growth Index Performance per decade (1995-2024)
Proponents of value investing argue that Growth’s extended outperformance has inflated its valuations, creating the conditions for an eventual reversal. To evaluate this, it is instructive to examine the relationship between valuations and returns.
The Role of Valuations
Exhibit 2 highlights a strong negative correlation between an index’s P/E ratio at the start of a decade and its subsequent ten-year returns. For Growth stocks, the correlation is -73%, compared to -37% for Value stocks, reinforcing the idea that higher valuations tend to predict lower future returns. However, the correlation between the P/E ratio difference of Growth and Value indices and their subsequent return difference is weaker (-0.33%), suggesting that factors beyond valuation differences largely drive relative performance.
Exhibit 2
y = -0.18x + 3.45
Where:
x = Excess of S&P 500 Growth P/E multiple over S&P 500 Value P/E multiple
y = Expected excess of S&P 500 Growth next-10-years’ annualized total return over S&P 500 Value Index next-10-years’ annualized return
Even under the hypothetical assumption that valuation alone determines future returns, the regression model presented above (calculated using data from 2001 to 2024) predicts a modest outperformance of Growth by 0.62 percentage points annually over the next decade. This finding refutes the claim that today’s wide valuation disparity guarantees a Value resurgence.
Alternative Perspectives
Skeptics of traditional valuation metrics highlight additional complexities. Modern accounting practices immediately expense investments in intangible assets such as R&D and subscriber acquisition, often making innovative companies appear overvalued by conventional measures. These discrepancies suggest that traditional definitions of Value may no longer identify truly undervalued stocks.
David Einhorn, in his first-quarter 2024 Greenlight Capital investor letter, reinforced this idea, pointing to the rise of passive investing as a key driver of market distortions. “A significant portion of investment capital today does not even consider valuation; it simply flows into passive index funds or is directed by retail investors with little training in valuation,” Einhorn wrote. Such structural changes challenge the traditional mechanisms by which Value stocks have historically outperformed.
This critique aligns with broader market dynamics. In a service-and-information-driven economy, companies like Nvidia, capable of adding two trillion dollars in market capitalization within a single year, highlight the diminishing relevance of capital-intensive industries where Value stocks have traditionally thrived.
Conclusion
The debate between Growth and Value investing reflects deeper questions about the nature of markets and economic progress. Value advocates often see their strategy as a testament to rigorous analysis and discipline, contrasting it with the perception of speculative luck fueling Growth. Yet, the evidence suggests that reliance on reversion to the mean may oversimplify the structural realities of modern markets.
While a Value resurgence is possible, factors such as sustained innovation, changing accounting standards, and the rise of passive investing challenge its inevitability. Investors should be cautious about strategies heavily dependent on Value outperformance simply because it has underperformed recently. As market dynamics evolve, so too may the definition of “mean.” Reversion, if it occurs, may lead to a new equilibrium altogether.
Commenti