Re-defining Value

The value premium may seem to have disappeared. Since 1926, cheaper stocks have outperformed expensive ones by 400% according to data from Normura (see graph below). Since February 2007, however, a value investor relying on price-to-book, which is the traditional measure of value and defining trait of the Russell 1000 Value Index, would not have reaped the gains that one would expect from this historical data. Why? Barron’s reports that, according to Joseph Mezrich of Nomura, “the market started to distinguish between different types of value” beginning after the dot-com bust. Price-to-book now appears linked with a higher probability of default. Price-to earnings, on the other hand, “became closely linked with profitability and less default risk.” Thus, the two measures “now usually move in opposite directions.”