Value Investing’s Heady Days Aren’t Coming Back, Study Says

Researchers argue that the value strategy has underperformed for longer than commonly believed — and that it’s unlikely to bounce back.

Michael Nagle/Bloomberg

Michael Nagle/Bloomberg

Value investing isn’t making a comeback any time soon, according to a pair of accounting professors from New York University and the University of Calgary.

In fact, the strategy may be on a much longer losing streak than many investors realize, argued professors Baruch Lev of NYU’s Stern School of Business and Anup Srivastava of Calgary’s Hasakayne School of Business.

“Despite the headlines about the recent demise of this strategy, it has been an inconsistent performer for almost 30 years now,” the authors wrote.

The origins of value investing are often traced to Benjamin Graham and David Dodd’s 1934 book “Security Analysis.” The approach involves buying stocks of companies which are seen as undervalued, and selling or shorting stocks that are believed to be overpriced, based on company financial data like earnings and book value.

Contemporary discussions around value investing often deal with strategy’s burst of success following the bursting of the dot-com bubble — and subsequent underperformance following the 2008 financial crisis. But Lev and Srivastava argue that, with the exception of the early 2000s, the value strategy has actually been underperforming since the late 1980s.

“The good performance of the value strategy in the early 2000s apparently looms large in the minds of relatively young investors, those who started investing in the 21st century, making it so hard to fathom the ‘demise of value’ since 2007,” they wrote. “The value strategy had already lost its potency in the late 1980s, and yielded negative returns in the 1990s.”

[II Deep Dive: Why This Value Investor Thinks Value Stocks Are About to Make a Comeback]

The two accounting professors suggested that the cause of value’s decline 30 years ago was not any particular change in the market, but in the way that companies calculate book value. According to Lev and Srivastava, public firms increasingly started expensing “intangibles” — value-creating investments in research and development, information technology, brand development, and human resources.

“This expensing of intangibles, leading to their absence from book values, started to have a major effect on financial data (book values, earnings) from the late 1980s, due to the growth of corporate investment in intangibles,” they wrote. “This book value mismeasurement was a major contributor to the demise of value investing which started in the late 1980s.”

In the absence of these “glaring accounting deficiencies,” Lev and Srivastava found that the value strategy would have delivered significantly higher returns from the late 1980s onward. However, the strategy still underperformed the market “significantly” in the wake of the financial crisis.

The authors theorized that the more recent underperformance of value investing has to do with the “sudden contraction of bank lending” post 2008.

“The prolonged decline of bank lending had a direct, adverse effect on the performance of banks… and an indirect effect on low-valuation firms which rely on bank lending to finance investment in innovation and growth,” they wrote.

In addition to being “cut off of much needed financing sources,” so-called value companies suffered from falling consumer demand after the recession, which caused profitability to plummet. At the same time, the highly valued growth or “glamour” companies in industries like software, pharmaceuticals, and electronics enjoyed high profitability and “easy access” to capital.

Although this disparity in performance might indicate that a reversion to the mean is overdue, Lev and Srivastava argued that most value companies still “don’t have the means to finance heavy investments” in research and development, meaning that a resurrection of the value strategy would require a “collapse” in “glamour” stocks similar to the dot-com bubble.

“What’s the likelihood of this to happen, and are there many investors who wish this to happen?” the authors wrote. “We doubt it.”