Value Still Waiting for a Catalyst

Value continues to look cheap, however predicting when it will begin to outperform is challenging. Russ suggests one potential catalyst: an unexpected acceleration in nominal economic growth.

The view that value looks cheap has become axiomatic; when value will actually start outperforming has been much harder to predict. Despite offering historically low valuations, at least relative to growth, value continues to lag. Year-to-date the Russell 1000 Growth Index has outperformed the Russell 1000 Value by over 11%.

Valuation gap

I last discussed this valuation gap in November. Since then it has only widened. Based on price-to-book (P/B), the Russell 1000 Value index has typically traded at around a 57% discount to the Growth Index. In November the discount was approaching 70%; today it is at 72%.

Does this suggest that value is even more of a “screaming buy”? Perhaps, but the timing is not obvious. The valuation gap looks less extreme depending on the exact valuation metric and time-frame. For example, although the current P/B discount looks out-sized relative to the long-term history, it looks less severe compared to the post-global financial crisis norm. Since 2010, value has traded at an average discount of 64%. In this light, current valuations appear less extreme.

You reach a similar conclusion by changing the valuation metric. Historically, based on trailing price-to-earnings (P/E), value has traded at a 25% discount to growth. Recently, stellar earnings growth has kept the P/E ratios for growth companies well below the nose-bleed levels of the late 1990’s. Today, value, based on trailing P/E trades at only a 32% discount to growth; larger than the historical average but not unprecedented.