Analysis looks into whether fundamental investors in search of mispricings should ignore value stocks from now on
It’s a well-documented trend: for the past decade, value has been eating growth’s dust in terms of performance. Many commentators have seen this and decided it’s time to say goodbye value investing – but according to one analysis, it should be just “goodbye for now.”
In a blog post published by the CFA Institute, Derek Horstmeyer, Morgan Rink, and Maximillian Simkins of George Mason University examined how much profit fundamental investors would make by looking for a market mis-estimation in a particular stock’s terminal value, dividends, or dividend growth rate. For each mis-estimation scenario, they calculated the returns that would be generated in the context of different interest-rate environments.
“The model is completely agnostic as to whether growth or value will outperform over the next 10 years,” the researchers said. “We simply sought to understand where our investor’s attention is most profitably directed in different rate environments.”
With respect to investors looking at the growth rate of dividends, they modelled the amount of profit an investor could make from a one-percentage-point market mis-estimation in dividend growth rate under varied rate environments, starting from a federal funds rate of 0 and going up to 20%.
“Researching a mis-estimation in the growth rate of dividends yields is most profitable for an investor in low interest rate environments,” they concluded, noting that the potential returns of that kind of approach would decline as the federal funds rate rises.
Repeating the analysis with an eye on a company’s terminal value, they came to a similar result: finding a 10% market mis-pricing in the stock’s terminal value at the end of 10 years would pay off the most in low-rate environments. For longer-horizon models that consider a 30-year term, the returns drop off more rapidly as interest rates rise.
Finally, running the analysis with a focus on current dividends yielded the opposite result: doing research and finding a 10% mispricing on the dividend paid tended to generate the greatest returns in high-interest-rate environments.
“All in all, the results highlight that in a near-zero interest rate environment, investors ought to keep an eye out for companies with high terminal values and significant growth rates in their earnings/dividends,” the researchers said.
