By Marcin Jendrzejczak with Katarzyna Plewa 

New Year 2022 presents an opportunity to be more thoughtful and take action. The same applies for investment decisions. In this context, it is worth refreshing one’s value investing philosophy and considering whether it will regain its former luster in 2022 after it fell out of favor in recent years.

Along with growth investing, value investing is an old investment strategy. The strategy involves purchasing companies at a discount to their true value. This is the classic example: buying shares at less than book value. You are talking here about purchasing a dollar for cents. A share is an ownership portion of a specific company, such as its patents and factories. This price is lower than what they actually are listed on the balance sheets.

Psychology of Value Investing

Warren Buffett’s investment strategy is value investing. His mentor Benjamin Graham calls it that. A long-term perspective is essential for value investing. Here, economists discuss low-time preference. It is a belief that every person will prefer current goods over future ones. This preference could be stronger or less. Under the possibility of profit, the person may be willing to sacrifice some income in order to obtain future income.

A value investor cannot be afraid to act against the crowd, as he follows the principle, “Buy when there is blood in the streets.” Sir John Templeton called this the principle of maximum pessimism. When the market has reached the ultimate conviction of its total despair, he encouraged stocks to be bought. 

Value stocks don’t always go up right away. Benjamin Graham (NYSE 🙂 stated that the market can be a voting machine for the short-term, but a weighing device for the long-term. In the short term, stock prices can plummet even more. However, at the end, stocks prices and valuations should be in line. 

The long-term benefits of value investing

Companies that value their customers win over the long-term and in the very long-term. According to Bank of America value investments have yielded 1,344,600% since 1926. Over that same period, yields from growth investments were “only” 626 600%.

Craig L. Israelsen, in an article summarizing research published on Financial Planning’s website, noted that cumulative annual growth over 25 years was 9.62%. The standard deviation was 18.25%. Thus, $10,000 invested in value investing grew to $993,350 over 25 years. However, the real return due to inflation was much lower. For large U.S. businesses, the premium for value investing was 86 basis point. The premium for medium-sized businesses was 99 basis points. It was even higher for small businesses, at 224 basis points  

Furthermore, the author also studied the situation over 21 5-year periods. The value category won 52% more cases than the large ones. Small companies were able to win 76% of the 5-year period with value (although they had an advantage up to 860 basis points in 1995-1999, when growth companies prevailed).

Research has revealed two key principles. The first is that the more time periods are, the greater the value investing opportunity. The second advantage is greater for smaller companies.

What is the difference between an exception and a new rule in the last 10 years?

This has been less apparent. Recent years have seen growth investing surpass value investing. The iShares Russell 1000 Growth Index (NYSE 🙂 has been returning 17% each year over the past decade while the iShares Russell 1000 Value Index NYSE : has returned only 10%. This is a shift in market sentiment that some analysts view as the result of technology companies. Some others recall the argument being made in 2000, just before the burst of the dotcom boom.

The world has changed. Proponents of the new economics argue that today’s capital is not as important as physical capital. It is instead human capital. Traditional ratios like price/profit and price/book value have become obsolete. A great IT business can have limited capital but still manage to be successful. Because its capital exists in the minds of people, this is why it is so successful. “Asset-light” is a positive for modern businesses, not a drawback.

Let’s have a look at this case. A Portfolio Visualizer portal “backtest”, covering 2011-21, showed that an ETF representing large U.S.-growth companies returned $58,056 at 2021. In contrast, an investment in the iShares S&P 500 Value ETF (NYSE:) representing large U.S. value companies yielded $31,764 at the end of the period.

For the first half, however, results were almost even. Therefore, the latter portion of the decade, particularly from April 2020 onwards, accounts for most of the differences. The growth advantage was just below $8,882 as of March 30, 2020 and rose to $26,292 at the end in 2021.

The comparison in the small-cap category is similar – the iShares S&P Small-Cap 600 Value ETF (NYSE:) versus the iShares S&P Small-Cap 600 Growth ETF (NASDAQ:). The annual cumulative returns were 11.56% and 13.64% respectively. At the end of this period, the 10,000 investment returned $7,383 less. Both portfolios were pretty well aligned up to 2017. The divergence began only after 2017.

In contrast, the iShares S&P Mid-Cap 400 Growth ETF (NYSE:) had an accumulated annual return of 12.49% and the $10,000 invested brought in $36,142, while the iShares S&P Mid-Cap 400 Value ETF (NYSE:) had an accumulated annual return of 11.27% and the $10,000 invested brought in $32,076 at the end of the period. The charts in this instance were fairly even up to March 2020.

It seems that the rise of growth businesses in recent years isn’t a trend shift, but rather an anomaly. This has been achieved by non-standard monetary policies, including asset purchase programs, negative real interest rates (and very low nominal), and other unconventional monetary policy. This is a striking correlation to the Fed’s Spring 2020 decisions. This is not a coincidence. It’s hard to see a cause and effect relationship. This is why it’s not an economic paradigm shift, but rather a Fed policy adjustment that was responsible for the huge valuations of growth businesses in recent years, especially after 2020.

The Fed’s withdrawal from a very dovish policy could lead to a sharp correction for growth companies. Higher levels of overvaluation will lead to a greater correction. The Fed anticipates that it will end the asset purchase program by the end Q1 2022. This will be followed by interest rate increases spread out over 2022-2023. One can easily imagine a scenario where the central bank would revert back to the old policy in the case of a negative reaction from the market. Inflation records will prove to be an obstacle that is difficult to overcome.

The recent high growth in companies can be seen as an argument that value businesses will again dominate the future. Capital flow may also be affected by the overvaluation of US markets. Investors looking for value will not just find companies in the American market that are expensive, but those found in Latin America and Russia as well.

The Growth Disparity: It’s Not Just In America

It’s important to note, however that excessively high valuations for growth companies is not a U.S. issue. Trustnet Magazine’s Anthony Luzio points out that the MSCI Growth Index of global growth stocks currently has a price-earnings ratio of 37.7. This is 2.5X higher than its value counterpart. Although growth stocks by definition are more expensive, it has historically been around 1.4X. The difference is now 2.5X. Even if you look at the world from a global perspective we see that growth stocks have been overvalued.

However, it is only a hypothesis. Uncertainty is the only certainty about the future. In the short term growth companies that are often connected to technology can provide truly amazing returns. Many experts recommend diversifying your portfolio. A diversified portfolio allows for the inclusion of different companies. However, it is possible to have one company dominate.

It is important to remember that, even though we may adopt a value-investing philosophy, which has historical data backing it, and common sense and large names, this should not be our only option. The future success or failure of a company is dependent on its value. However, low valuation can be an important indicator. The other important factors are size (smaller companies tend to have higher profits, but more volatility), quality (company finances) and momentum (what was successful last year often performs better in the future). Some might suggest that growth companies should be included in a portfolio. However, they need to be carefully selected or should be part of ETFs. Then we do not depend on a single company, which can often transition from today’s market darling to tomorrow’s bankruptcy. Today’s Amazons are among the fastest growing companies, but there’s also many other companies that won’t thrive or survive. 

A small company with high quality financials that is also cheap and whose shares have started to rise again seems like the perfect business. We can see that there is much evidence to suggest 2022 will be a year of return to value investment. This year, however, offers an opportunity for investors to develop an investment strategy based upon professional valuations and analyst opinions. You can only succeed if you have patience and don’t let your greed get in the way of success.