For much of the post-crisis period investors consistently craved growth stocks. They did so for the same reason they favored stocks with a healthy dividend: Both income and growth were scarce commodities for much of the past eight years. However, with yields rising and economic growth at least stabilizing, this began to change in the second half of 2016 when classic dividend plays stumbled while value started to come back into vogue. However, these trends stalled in January, raising the question of whether the recent preference for value has further to go. My view is that it does, primarily because value still appears cheap relative to growth.
The notion of the “value of value” seems a bit redundant, but it is important when assessing style preferences. While value stocks, by definition, will trade at a lower valuation than growth stocks, the valuation spread moves over time. Based on the price-to-book (P/B) metric, since 1995, value stocks, as defined by the Russell 1000 Value Index, have typically traded at around a 55% discount to growth stocks.
During the tech bubble growth stocks became more expensive, pushing the value discount to more than 70% at the market peak in 2000. Conversely, prior to the bursting of the housing bubble, it was value that looked expensive. The rally in financial shares, which typically command a higher weight in value indexes, drove the value discount down to around 45% in 2006. The chart below illustrates this, showing the ratio of the value P/B to growth P/B. A relative ratio of 0.55, for example, translates into a value discount of 45%.