The Best Time to Invest in Value

The Best Time to Invest in Value

A recent study found that the value premium emerges only after the overall market becomes either highly overvalued or deeply undervalued. This according to a recent article in Institutional Investor.

The study, which examined value performance between 1968 and 2018, found that between 60 percent and 80 percent of the time, the value premium either “does not exist or is very low,” the article reports. The researchers found that value returns are primarily driven by “extrapolators”— investors who purchase stocks based on the belief that markets will keep rising or, conversely, sell them based on a belief that markets will continue to fall.

“In other words,” the article explains, “these market-chasing investors favor growth stocks, increasing the valuation gap between these high-flyers and stocks with lower or negative cash-flow shocks—the value stocks. It’s the eventual correction of these mispricings that results in the value premium.”

The researchers noted, “when people are excited about stocks in general, they are particularly excited about growth stocks; and when they are depressed about the stock market, they are particularly depressed about value stocks.” The study also found that the value premiums were highest after periods of extremely positive or negative market expectations—specifically, that the monthly value premium was 1.5 percent after periods of extreme optimism, and 3.5 percent after periods of extreme pessimism.

The study findings suggest that there are “quantifiable benefits” to timing exposures to value stocks based on overall market conditions.