Asset Pricing: Trouble in Value Land

Abstract

Empirical literature on value and growth style investing has found value style investing to be a favorable long-term investment strategy. However, value investing has lost its edge in the past 10–12 years. As a result, the value premium has been proclaimed dead by institutional investors who argue common valuation multiples, such as price to book, are not valid proxies for valuation. In this article we argue that the academic definition of value investing is structurally flawed. Common valuation multiples do not indicate mispricing (cheap vs. expensive) but rather investors’ discount rate, which is a denominator metric in valuation. We discuss the practical application of a new definition of value, and provide both theoretical and empirical evidence that a disruptive growth stock valuation premium exists in equity markets. We argue that in the past decade the valuation premium in growth stocks has been the main driver of their outperformance.

TOPICS: Style investing, private equity, portfolio construction, equity portfolio management

Key Findings

• • The academic definition of value investing has markedly underperformed for more than a decade.

• • In this article we argue that the under performance of value investing is a result of the lack of a valid asset pricing model.

• • We introduce a new definition of ‘value’ and a value premium that can be captured in all stocks, regardless whether stocks are classified as growth, value, large or small cap stocks.