The Value Drought
Value investing—buying cheap stocks and avoiding expensive ones—has been one of the most celebrated strategies in finance. From Graham and Dodd to Warren Buffett, generations of investors have profited from the value premium. Yet since 2007, traditional value strategies have dramatically underperformed, leading many to question whether the factor is dead.
This paper examines the structural changes that may explain value's struggles and assesses whether the factor retains predictive power for future returns.
The Magnitude of Underperformance
From 2007 to 2024, the Fama-French value factor (HML) delivered cumulative returns of -28% versus its historical average of +4.5% annually. This represents the longest and deepest value drawdown on record.
Why Has Value Struggled?
Several explanations have been proposed for value's underperformance:
Interest Rate Environment
Ultra-low interest rates have favored growth stocks with distant cash flows. When discount rates approach zero, the present value of future growth becomes extraordinarily valuable, widening the gap between growth and value stocks.
Intangible Economy
Traditional value metrics (P/B, P/E) were designed for asset-heavy businesses. In today's economy dominated by software, brands, and intellectual property, book value increasingly understates true economic value. Companies like Microsoft and Google appear "expensive" on traditional metrics but may actually be undervalued relative to their intangible assets.
Disruption Risk
Many value stocks are cheap because they face existential threats from technological disruption. Traditional retailers, legacy media, and old-economy industrials trade at low multiples for good reason—their business models are under attack.
Is Value Dead or Sleeping?
We believe the evidence suggests value is sleeping, not dead:
- Historical precedent: Value has experienced extended drawdowns before (early 1930s, late 1990s) and recovered strongly
- Valuation spread: The gap between cheap and expensive stocks is at historically extreme levels, suggesting mean-reversion potential
- Behavioral foundations: The psychological biases that create value opportunities (overextrapolation, loss aversion) haven't disappeared
- International evidence: Value has performed better outside the U.S., suggesting country-specific rather than universal factor decay
Modernizing Value
Rather than abandoning value, we advocate for modernizing its implementation:
Intangible-Adjusted Metrics
Capitalizing R&D and marketing expenditures, adjusting for lease obligations, and incorporating customer value significantly improves value signal quality.
Quality Filters
Combining value with quality screens (profitability, earnings stability, low leverage) eliminates "value traps"—cheap stocks that deserve to be cheap.
Sector-Relative Value
Comparing valuations within sectors rather than across the entire market reduces the bias toward old-economy sectors that may face structural headwinds.
Conclusion
The value factor is experiencing its most challenging period in history, but we believe it remains a valid source of long-term returns. The key is modernizing implementation to account for the intangible economy while maintaining discipline through the current drawdown. History suggests that patient value investors who can withstand extended underperformance are eventually rewarded—often spectacularly when mean reversion finally occurs.