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Posted by on February 14, 2007, 9:54 am
James Altucher just wrote at realmoney.com (a pay site) that "many
growth indices (Value Line, in particular) actually have lower P/E
ratios than their value counterparts."
The TickerSense site
http://tickersense.typepad.com/ticker_sense/2007/01/growth_value_vs.html
wrote on 1/26/2007,
"Don Hays appeared on CNBC this afternoon and said that investors
should be focused on growth stocks, as that group provides the best
opportunity for gains in the year ahead. His argument makes sense.
The table below highlights the PE ratio of the growth and value
indices for the S&P 500 (large cap), S&P 400 (mid cap), and the S&P
600 (small cap). As you can see, in the mid cap and small cap
indices, the aggregate P/E ratio for growth stocks is actually lower
than value stocks. In other words, growth stocks are a better value
than value stocks (Yes you read that right!).
PE Ratio (Trailing)
value growth
large cap 16.9 18.6
mid cap 21.2 20.5
small cap 23.4 20.1
So investors should invest in growth stocks right? But what exactly is
a growth stock? Apparently, that is a tougher question than you would
expect. S&P apparently, is not so sure. Currently, there are 162
stocks in the S&P 500 that are in both the S&P 500 value and growth
indices."
The S&P value and growth indices used to be maintained in conjunction
with BARRA, using price/book as the criterion. The S&P/Barra Style
indexes ceased to be the official Standard & Poor's Style indices in
December 2005.
Now the S&P style indices use a multifactor model of Citigroup with
the following growth and value factors:
Growth Factors
5-Year Earnings per Share Growth Rate
5-Year Sales per Share Growth Rate
5-Year Internal Growth Rate (IGR)
(IGR = ROE x Earnings Retention Rate)
Value Factors
Book Value to Price Ratio
Cash Flow to Price Ratio
Sales to Price Ratio
Dividend Yield
Value Factors
I think that the current compression in earnings multiples between
growth and value stocks means that the value premium (the expected
return differential of value over growth stocks) is small right now.
In 2000 there was a much bigger difference in earnings multiples
between value and growth stocks, and with some hindsight, one can also
that the value premium was also much higher.
I wonder how closely the value and growth ETFs and index mutual funds
conform to the definitions of value used by academics who have studied
the "value premium".
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Posted by on February 14, 2007, 10:53 am
On Feb 14, 2:54 pm, beliav...@aol.com wrote:
> I wonder how closely the value and growth ETFs and index mutual funds
> conform to the definitions of value used by academics who have studied
> the "value premium".
good analysis. Thank you.
The short answer is I suspect there has been 'style drift'. Value and
growth are getting rather confused (as you point out).
So telecommunications, media and some technology stocks, and some
pharma cos are 'value' whereas some resource stocks make have become
'growth'. Banks tend to figure prominently in 'value' indices, since
they habitually trade at lower PEs than the market.
Value in an academic context is almost always price to book (or rather
book to market value in the econometric tests). Studies of other
measures don't show the same 'value effect'.
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Posted by Tad Borek on February 14, 2007, 1:31 pm
beliavsky@aol.com wrote:
> I wonder how closely the value and growth ETFs and index mutual funds
> conform to the definitions of value used by academics who have studied
> the "value premium".
B, I think you know this, but you could look at that by comparing the
characteristics of DFA's mutual funds with analogous ETFs whose
portfolios are based on published indices. Ostensibly that was their
motivation for founding DFA -- mutual funds that were "true to the
research". I have some materials from them showing comparisons to
indices, but unfortunately they're stamped all over "advisor use only".
From publicly available info you can see that there are differences in
number of securities, market cap, and book-to-market metrics for some
portfolios. Whether these differences will persistently result in
performance differences is open to debate, especially when factoring in
the costs one might pay to access these funds, vs. ETFs (including tax
costs, if that's relevant).
On your general point - I thought of this when you posted a similar
paper recently...I've always though that the value premium, at least in
part, can be explained as the advantage you get when you avoid bubble
stocks. A value investor systematically avoids them. If widescale
mispricings (and resulting crashes) are periodic events in equities
markets, both on a macro scale and with smaller batches or sectors of
securities, the value investor benefits from systematically avoiding
these events - or at least, not buying those securities during the peaks
in valuation. And to a lesser extent, that investor avoids the more
subtle bubble-buying, on the individual-security level -- such as that
experienced by someone owning a Nasdaq 100 tracking fund (which adds
stocks only after they've run up far enough to be one of the 100 largest
by market cap...perhaps systematically "buying high"?).
To the extent this thesis holds water, it would make sense that there
would be an ebb and flow to the value premium. When you're in a bubble,
you benefit from overweighting value, when the market is more fairly
valued, you don't. Of course the catch is identifying these periods
using something other than hindsight.
-Tad
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Posted by David Moore on February 15, 2007, 4:57 am
Remember that these indicators suggested a year ago that growth
"should" outperform value. Didn't happen.
Lots of evidence indicates that such attempts to time markets
are futile. The only things true about the market are true only
on the average in the long run. On the average in the long run,
value outperforms growth and probably small outperforms large.
This year? Nobody can say.
The way of wisdom is to choose an asset allocation that tilts
toward value and small and is appropriate for your age, wealth,
and risk tolerance. You can do this with Vanguard or even
better with DFA. Then sit on your hands, resisting the temptation
to trade. In a few decades, you will probably be rich. As
Warren Buffet said, "Activity is the enemy of investing."
One small coda, which I hesitate to bring up because it may open the
gates of temptation. There is some evidence of slight mean reversion
in the market. That is, on the average in the long run, periods of
above-trend performance tend to be followed by periods of
underperformance. The effect is small and is overwhelmed by noise at
time periods less than (perhaps) a decade or so. But in practical
terms, the books by Malkiel (1980) and Schiller (2000) performed
similar comparisons of stock prices with economic, historical, and
value measures. Malkiel found that stocks were shockingly undervalued
-- he was two years early, but the great 18-year bull market started in
1982. Schiller was lucky (and it was just luck) to hit the top almost
exactly. Despite the "Dow hits record" hype, the S&P 500 is still 5%
below its March 2000 high and the NASDAQ is straining to get back to
half its March 2000 value -- 7 years later. Keep repeating "only on
the average in the long run" and remember that in this game 7 years is
not the long run. A convincing call every 20 years may be about all we
can look for.
David
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Posted by Will Trice on February 14, 2007, 6:41 pm
beliavsky@aol.com wrote:
> As you can see, in the mid cap and small cap
> indices, the aggregate P/E ratio for growth stocks is actually lower
> than value stocks. In other words, growth stocks are a better value
> than value stocks (Yes you read that right!).
It's interesting that P/E is used to measure value...
>
> Now the S&P style indices use a multifactor model of Citigroup with
> the following growth and value factors:
>
> Growth Factors
> 5-Year Earnings per Share Growth Rate
> 5-Year Sales per Share Growth Rate
> 5-Year Internal Growth Rate (IGR)
> (IGR = ROE x Earnings Retention Rate)
>
> Value Factors
> Book Value to Price Ratio
> Cash Flow to Price Ratio
> Sales to Price Ratio
> Dividend Yield
> Value Factors
....but it is not used to measure value... How then does one measure the
premium?
-Will
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