By Frank Armstrong

If you haven't noticed, value is back. So much attention has been focused on the collapse of the growth and tech sectors that you might be forgiven if you thought that the whole market had tanked. It hasn't. Value investors are doing quite nicely, thank you. Amid the widely reported carnage value investors are actually experiencing strong profits! But, the media seems to be totally ignoring the story.

The long dry spell

It's been a long dry spell for value investors. Growth was the fad de jour for the entire last half of the nineties, driving up prices to unsustainable levels. For a while, many investors convinced themselves that growth was a risk free investment. Value investors were ridiculed and scorned as the growth/tech bubble steadily inflated. But, after several years of disappointing relative performance, value is outperforming growth by some of the widest margins ever.

Recent performance

During year ending February 28, 2001 the S&P 500 lost 8.2%. (See below for definitions of each of these indexes). But look what happens if we split the index into growth and value. The S&P 500/Barra Growth index lost -25.79% while the S&P 500/Barra Value index gained 13.73%. That's a difference of 39.52%!

The same relative performance held for smaller stocks. The S&P Small Cap 600 index lost 0.37%. But the S&P Small Cap 600/Barra Growth lost a staggering 22.72%, while the S&P Small Cap 600/Barra Value gained an impressive 25.97%. The spread between the growth and value sides was an astounding 48.69%!

Value and growth defined

As a quick review, growth companies are generally healthy, and have good prospects. Value companies are distressed and suffer from weak financial performance. Being ugly, nobody really wants to buy them. So, the price of value stocks gets driven down until a buyer could expect a higher return from buying a poorly performing company than buying a glamorous growth stock. An economist would say that distressed companies have higher costs of capital, and that cost is reflected in the stock price. The additional return that value investors earn is called the value premium.

Value style carries its own risks

That's the theory, and in the long run value investing has had higher returns than growth by a wide margin without additional risk as measured by volatility. But, the value premium has its own price, as we would expect in a world without free lunches. Value stocks may go for long periods during which they underperform growth as we have just seen.

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Given the cyclical nature of all investing styles, it was inevitable that value would return. But, the timing couldn't be forecast. And it would be a mistake to forecast that value will continue to dominate. It might or might not. Short-term predictions are pointless in an atmosphere of uncertainty and randomness.

What we should learn from this is that a disciplined diversified portfolio with a value tilt still makes sense. During the 90′s value dry spell, value investors made money when growth stocks soared. Not as much, but they kept it all when growth stocks tanked.


Over the long haul, value investing has been a far superior style than growth. Discipline and diversification are the two keys to long-term success. After all, investing is a marathon, not a sprint. Those stories remain intact.

*Source: Standard & Poor's

Index Definitions:

S&P 500 Index: The 500 stocks in this capitalization-weighted index are chosen by financial information firm Standard and Poor's based on industry representation, liquidity, and stability. The S&P 500 is not composed of the 500 largest companies but rather is designed to capture the returns of many different sectors of the US economy. The index is composed of roughly 400 industrial, 40 utility, 40 financial, and 20 transportation stocks.

The S&P/BARRA Large Cap Growth Index is the growth (as opposed to value) portion of the S&P 500 Index. The result of collaboration between financial information firms Standard & Poor's and Barra, Inc., this capitalization index tracks the half of the S&P 500 stocks with the highest ratio between book value and stock price, or book-to-price ratio.

The S&P/BARRA Large Cap Value Index, like its twin, is constructed by dividing the stocks in the S&P 500 index according to book-to-price ratio. In this capitalization-weighted index firms have higher bookto- price ratios and therefore belong to the value half of the index.

The S&P Small Cap 600 Index: A capitalization weighted small company index created by Standard and Poors to represent smaller firm performance.

The S&P/BARRA Small Cap Growth Index is the half of the S&P Small Cap Index of stocks with higher book-to-price ratio.

The S&P/BARRA Small Cap Value Index tracks the half of the S&P Small Cap Index of stocks with the highest book-to-value ratios.