Has the Value Trade Become Overcrowded?

As the chief research officer for the Buckingham Family of Financial Services, one of the issues I’m asked about more and more is the underperformance of U.S. value stocks over the last decade. The main concern I hear is that the underperformance is a result of the trade becoming overcrowded post-publication of the academic findings demonstrating a significant value premium around the globe as well as across asset classes.

We can address the issue of overcrowding by examining the spreads in valuations of growth and value stocks. If overcrowding has occurred, we should see a dramatic narrowing in valuations.

Have spreads narrowed?

We can measure the spread in valuations by using data from Ken French’s data library. The data is based on a 2-by-3 matrix, splitting the market into large (top 50%) and small (bottom 50%); and value (cheapest 30%), core (middle 40%) and growth (most expensive 30%). The portfolios include utilities and financials and use a weighted average market cap.

At the end of 1993, right after the publication of the original famous Fama-French research on the size and value premiums, the price-to-book (P/B) of U.S. large growth stocks was 4.4 times that of U.S. large value stocks, and the ratio of their price-to-earnings (P/E) was 3.1 times. If there was overcrowding, we should see narrowing of the spreads, as cash flowing into value stocks and out of growth stocks impacts relative prices.

Contrary to the conventional wisdom that would theorize the spread had narrowed, we find that at the end of 2018, the P/B ratio had widened from 4.4 to 5.4 (a relative increase of 23%), and the P/E ratio had widened from 3.1 to 5.0 (a relative increase of 61%). Turning to small stocks we see similar evidence.

At the end of 1993, the P/B of U.S. small growth stocks was 5.4 times that of U.S. small value stocks, and the ratio of their P/Es was 4.2. At the end of 2018, the P/B ratio had widened from 5.4 to 5.9 (a relative increase of 9%), and the P/E ratio had widened from 4.2 to 6.1 (a relative increase of 45%).