One of the more vocal arguments against value investing stems from a belief that we’re in a “new normal” environment where innovative or high-tech companies have a leg up on “old guard” industries, such as energy or financials.
FAANG stocks have typically been the poster children for this position; these behemoth technology companies have contributed meaningfully to the market’s overall return and, by virtue of being growth stocks, the negative value premiums in recent years.
Well, guess who showed up as value this summer!
That’s right, Russell reclassified Meta (formerly Facebook, the “F” in FAANG) and Netflix (the “N”) from growth to value during the index provider’s annual reconstitution event. Although signs have been pointing to the waning dominance of FAANG stocks since the start of 2022, it is somewhat ironic that 40% of the pillars supporting an aversion to value investing have now become value stocks themselves.
This also serves to highlight a possible misconception about the spirit of value investing.
A value premium is a discount-rate effect: If expected future cash flows are not identically discounted for all stocks, then the ones with low prices relative to their expected future cash flows have higher expected returns.
Investors advocating for the superiority of growth firms, such as the FAANGs, are inadvertently making the case for their expected future cash flows to be discounted at a lower level—all else equal, greater certainty around future success should be associated with a lower expected return.
In fact, as Exhibit 1 shows, this is generally what we see for stocks of companies once they grow to become among the largest in the market.
In other words, investors should be careful about equating expected company success with expected stock returns.
What Have You Done for Me Lately?
Average annualized outperformance of companies before and after the first year they became one of 10 largest in US
(Compared to Fama/French Total US Market Research Index, 1927–2021)
Past performance is no guarantee of future results.
As with any prudent investment strategy, chasing performance is hardly a strategy that pays off when it comes to future expected return. We never know what that next top 10 stock will be, and as the world continues to evolve, new companies and industries continue to advance and decline. A diversified approach with the proper mix to value and growth can help attribute to the long-term success of your stock market portfolio.
If you have any questions about your current holdings or would like a second opinion, please reach out to our team!
This information is intended for educational purposes and should not be considered a recommendation to buy or sell a particular security. Named securities may be held in accounts managed by Dimensional. The stocks commonly referred to by the FAANG moniker are Facebook (now trading as Meta), Amazon, Apple, Netflix, and Google (now trading as Alphabet).
Fama/French Total US Market Research Index: The value-weighted US market index is constructed every month, using all issues listed on the NYSE, AMEX, or Nasdaq with available outstanding shares and valid prices for that month and the month before. Exclusions: American depositary receipts. Sources: CRSP for value-weighted US market return. Rebalancing: Monthly. Dividends: Reinvested in the paying company until the portfolio is rebalanced.
Results shown during periods prior to each index’s index inception date do not represent actual returns of the respective index. Other periods selected may have different results, including losses. Backtested index performance is hypothetical and is provided for informational purposes only to indicate historical performance had the index been calculated over the relevant time periods. Backtested performance results assume the reinvestment of dividends and capital gains. Eugene Fama and Ken French are members of the Board of Directors of the general partner of, and provide consulting services to, Dimensional Fund Advisors LP.
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