Value investing, a bankable strategy for decades, has fallen on hard times. Value stocks have badly underperformed growth ones since around 2007, and the trend has accelerated in recent years. Disappointed value investors understandably want answers, and several popular and appealing explanations are making the rounds. The problem is they don’t quite stand up to scrutiny.

One theory is that value investing has become too popular. The discovery in the early 1990s that value had historically beaten growth is said to have triggered a stampede into value stocks that raised their prices and thereby doomed the strategy. It’s true that popularity can be lethal to any investing strategy — just ask hedge funds, or more recently, private equity. But has value been overrun with investors?  

One way to find out is to break out the return from growth and value stocks into their three components: dividends, earnings growth and change in valuation. Companies supply the first two, and the last one is driven by demand for their stock. Isolating the change in valuation is therefore a window into what investors want.

Contrary to value’s supposed popularity, the numbers reveal that investors are more interested in growth. Since 1995, soon after value’s historical thumping of growth was documented and the earliest year for which earnings numbers are available, growth has beaten value by 1.6 percentage points a year through September, as measured by the Russell 1000 growth and value indexes. The sum of dividends and earnings growth was nearly identical for both, favoring growth by just 0.3 percentage points. The other 1.3 percentage points came from change in valuation, which shows that growth’s success was due mostly to greater demand for its stocks. If anything, in other words, it’s growth’s popularity that felled value. 

Those numbers jibe with the assets sitting in growth and value funds, which also belie the notion that value has surged in popularity. In 1993, U.S. growth funds managed $130 billion more than value ones, according to Morningstar, and more money has been invested in growth ever since. The difference is now bigger than ever. In October, growth funds oversaw a record $1.5 trillion more than value. If value is indeed more popular than growth, investors have a funny way of showing it.  

Investors’ apparent preference for growth feeds a second theory, which is that low interest rates have juiced demand for growth stocks. The idea is that investors gauge the value of companies in part by discounting future cash flows. When interest rates decline, so does the discount rate, which makes future cash flows more valuable. And because, by definition, growth companies are expected to make more money, lower interest rates boost their valuations more than those of value companies. 

It’s true that the valuation of growth stocks has swelled more than that of value since growth’s current win streak began around 2007. It’s also true that the 10-year Treasury yield fell from roughly 5% to around 1% during that time. But that’s just one period. Looking at all the available data, there appears to be little correlation between the movement of interest rates and the difference in valuation between growth and value stocks.

The correlation between 10-year Treasury yields and the difference in price-to-book ratio between growth and value has been a negative 0.14 since 1926, which is to say no discernible relationship. Using price-to-earnings ratio or price-to-cash-flow ratio, the correlation jumps modestly to a negative 0.33 since 1951, which is best described as a faint relationship. So changes in interest rates don’t appear to reliably inform how much more investors are willing to pay for growth than value. (A correlation of 1 implies that two variables move perfectly in the same direction, whereas a correlation of negative 1 implies that two variables move perfectly in the opposite direction.)

A third theory is that there’s nothing wrong with value investing; rather, it’s value investors who are broken. The purists, let’s call them, contend that buying a value index fund that slavishly picks stocks based on quantitative measures such as price-to-book or price-to-earnings ratios, as value investors are increasingly doing, isn’t value investing at all. Real value investors, they contend, research stocks exhaustively to find undervalued companies. Invariably, Warren Buffett, who famously pores over companies’ financial statements, is then paraded out as proof that true value investing works.

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