Quality Enhances Value for Investors After Market Crises

Market crises and macroeconomic recessions typically create fertile ground for value stocks to outperform in a recovery. Our research suggests that higher-quality stocks with strong profitability credentials can deliver even better results after a crisis.

Since value stocks are widely perceived as higher-risk assets, they typically benefit from risk-on market environments after a market shock. Value stocks are also more prevalent in sectors that are more sensitive to macroeconomic cycles, such as industrials or materials, which tend to shine when GDP growth recovers. Indeed, the Russell 1000 Value Index surged by 37.9% from November 2020 through April 2021, as COVID-19 vaccine rollouts inspired confidence in the nascent recovery.

However, after value stocks underperformed in the second quarter, some investors wonder whether the value recovery has run its course. We think there’s more to come, and a focus on high-quality stocks should be particularly rewarding over time.

Quality Focus Bolsters Return Potential

To gauge the potential, we looked at five major shocks since 1990, when the market fell by at least 10% from the beginning to the end of a quarter. In each, we analyzed the performance of US value stocks, defined by the tercile of companies with the highest free-cash-flow (FCF) yield, as well as the highest-quality group within that tercile, based on the FCF/assets ratio. Performance was measured over a two-year period, beginning six months before the market trough to account for the fact that it’s almost impossible for investors to time a downturn or inflection point with precision.