Rediscovering the Potential of Downtrodden Value Stocks
The coronavirus crisis and recession have pummeled value stocks as investors shun riskier parts of the market. Yet these conditions have left some higher-quality companies trading at valuations that underestimate their ability to withstand shorter-term stress—and their longer-term recovery potential.
Value stocks have been unloved by investors for years. After about a decade of underperformance, the economic damage from the coronavirus crisis has been especially painful. With the world reeling from a global health crisis and economic shock, global and US value stocks fell harder than the broader market during the sell-off. And even though they’ve clawed back losses in the recovery since March, value stocks still haven’t caught up with the market.
The MSCI World Value Index had fallen by 15.9% in the year to date through June 18. In the US, the Russell 1000 Value Index was down 14.5%. Both trailed the broader benchmarks by over 10% in that period.
So why has this year been so harsh for value investors? Mostly because value stocks are widely seen to be cyclically sensitive, which makes them more vulnerable to macroeconomic downturns. Indeed, value stock underperformance intensified over the past three years amid growing concerns that the global economic recovery since the global financial crisis was running out of steam. Those concerns were magnified by last year’s US-China trade dispute. Then, the economic recession driven by stay-at-home measures to combat the virus escalated those fears. Despite attractive valuations relative to their growth peers, value stocks sold off further as these concerns materialized.
Deep Discount: Value on Sale in COVID-19 Crisis
Now, however, value stocks are deeply discounted. The MSCI World Value is 58% cheaper than the MSCI World Growth, based on a combination of three value metrics: price/sales, price/cash flow and price/forward earnings (Display, left). That’s almost the deepest discount in 20 years. In the US, the Russell 1000 Value trades at a 56% discount to its growth counterpart (Display, right)—also close to historical low levels. And in US small- and mid-cap stocks, the value-to-growth discount is even deeper.