We think investors willing to expand their traditional investment toolset to incorporate extra-financial factors stand to reap superior returns over time.
February 7, 2024
By Kyle Bergacker, CFA
The seeds of traditional value investing were sown by Benjamin Graham in
his seminal works “Security Analysis” and “The Intelligent Investor: The
Definitive Book on Value Investing,” published in 1934 and 1949,
respectively. Graham’s work stands as the keystone of modern investment
analysis, shifting the conversation around investing from
speculation – which was the default practice prior to the 1929 stock market
crash – to one of intrinsic value, or the calculated real value of a
business based on earnings, assets, liabilities, and cash flows, among
Graham’s intrinsic value framework argued that stocks trading in
short-term irrational markets may have a price that is higher or lower
than what the business is really worth. This dislocation between what a
company’s price is in the marketplace and what it ought to be based on
company fundamentals over the long term means that a prudent investor
should buy when market prices are lower than intrinsic value and sell when
they are higher.
Building on the work of Graham, in 1992, Eugene Fama and Kenneth French
developed a three-factor model that introduced size and value as
investment factors in addition to market expectations that Graham and
others had pioneered a generation earlier. Their work around these
additional investment factors underscored Graham’s fundamental axiom that
the market can be irrational in the short term but is efficient over time.
Again, this means that investors should:
The resultant strategy – selecting value over growth – has been tremendously
successful over the last 100 years, despite persistent weakness since
The line chart shows cumulative returns for an investment strategy
based on buying “high book-to-market ratio minus low” (HML) companies
from 1927 through 2022. The chart shows that value as a factor has
steadily outperformed growth as a factor from 1927 until 2007 where
the upward right line peaks at roughly 600 percent cumulative returns
and starts to trend back downwards. A secondary chart highlights this
downward revision between 2007 through 2022 with a vertical axis from
440% to 580%. The secondary chart starts in 2007 at nearly 560% and
ends in 2022 at roughly 510%.
Source – Ken French, RBC Wealth Management
Simply put, no. Warren Buffett, a student of Benjamin Graham’s when the
latter taught at Columbia Business School, describes it most neatly:
“There is no such thing as growth stocks or value stocks as Wall Street
generally portrays them, as contrasting asset classes. Growth is part of
the value equation.”
If true, how can we best see that this is the case and what happens if
growth is slow or absent?
We can utilise index returns and their decomposition to better understand
what underlying components drove value and growth returns over time and
why value as a factor hasn’t worked relative to growth for nearly two
decades. To illustrate, we will look at key drivers of return including:
For comparison, we will use the Russell 1000 Value Index (the Value Index)
and the Russell 1000 Growth Index (the Growth Index).
We focus on two key periods. The first is from 1995 through 2006 during
which value continued to work as it always had; we denote this as the
“traditional value” regime. The second is from 2007 through 2023 where
value as a factor no longer seemed to work in the same way; we’ll call
this the “intangible value” regime.
Let’s look at the total shareholder returns data for each index and for
The first observation is revelatory in that intangible value clearly has a
growth problem … specifically, a lack thereof.
The exhibit consists of two separate column charts that break down
total shareholder returns for Value and Growth investment styles.
These returns are divided into four categories: EPS growth, multiple
expansion, dividend yield, and dividend reinvestment. For each of
these categories, returns are further broken down into two time
periods: “traditional” from 1995 to 2006, and “intangible” from 2007
to 2023. In the Value style chart, EPS growth is 8.8% for the
traditional period vs. 3.3% for the intangible period, multiple
expansion is 2.4% vs. 0.8%, dividend yield is 2.5% vs. 2.5%, and
dividend reinvestment is 0.2% vs. 0.1%. In the Growth style chart, EPS
growth is 5.5% for the traditional period vs. 6.4% for the intangible
period, multiple expansion is 2.6% vs. 4.1%, dividend yield is 1.0%
vs. 1.3%, and dividend reinvestment is 0.1% vs. 0.2%.
Source – RBC Wealth Management, Bloomberg
On the value chart we can see that EPS growth for the Value Index was
very strong in the 1995–2006 period, rising by 8.8 percent per annum. That
persistent strength persuaded investors to pay more for each dollar of
current earnings (i.e., boost the P/E multiple or sometimes known as
“animal spirits”), adding a further 2.4 percent per annum to already
robust returns. But in the following 2007–2023 period, earnings growth
slowed markedly to just 3.3 percent per annum. Investors lost their
enthusiasm for the Value Index with returns from valuation expansion
collapsing by two-thirds to just 0.8 percent.
But the growth chart shows a very different outcome for the Growth
Index. Moderate EPS growth in the 1995–2006 stretch accelerated somewhat
to a healthy 6.4 percent per annum from 2007 to 2023 at the same time as
value returns sagged by almost two-thirds. Investors’ “animal spirits”
were aroused as they headed toward the superior EPS returns of the Growth
Index, in the process boosting the added returns delivered by P/E
expansion by a rich 4.1 percent per annum compounded over 16 years.
Not just in the 1995–2006 period depicted in the charts but throughout the
entirety of the 20th century traditional value had seemingly benefited
from the advent and evolution of operations management (i.e., mass
production, Six Sigma, just-in-time, “kaizen” or the Japanese concept of
continuous improvement, etc.). Process enhancements and the introduction
of rudimentary technology and automation for mass manufacturing of real
goods in the real economy are strong contenders in providing explanation
for most of the century-long earnings tailwinds that traditional value
companies had benefited from.
That said, it seems fair to suggest that over the intangible growth regime
from 2007 to 2023, earnings have expanded in large part from the rise and
utilisation of new, disruptive technologies which saw dramatic inflection
and adoption in the early 2000s (i.e., internet, mobile broadband, Wi-Fi,
laptops, social media, smartphones, instant payments, smart devices,
software-as-a-service, etc.). Having this first-mover advantage with
radically improved technology has helped to build business efficiencies
across key financial and extra-financial factors (i.e., factors that are
not captured in the financial statements) such as human and social capital
management, along with business model improvements in ways that were never
The integration of technology generated meaningfully robust intangible
assets and business efficiencies that have translated to continued
earnings growth. This has led investors to drive up the intangible growth
multiple from 2.6 percent to 4.1 percent of the per annum price
appreciation figure for the index between the two periods, with the
anticipation that there is more to come.
Not exactly, but the world is a different place today. As the digital
economy and technologies continue to grow and mature, we do believe that
some old dogs can learn new tricks.
Consider the backbone of technology – an extra-financial metric known as
human and social capital, or simply put, people. Without talented,
technologically adept people, or the incentive structures to attract and
retain them (i.e., pay, career growth, job satisfaction, corporate
culture, and other notorious tech company-related perks like free lattes,
nap pods, or bringing your dog to work …), incremental growth and
innovation at the leading edges will begin to slow. Likewise, as
technology innovation has concentrated this skilled labour in very few
pockets across the intangible growth universe, marginal gains from
high-caliber talent across maturing platforms will eventually approach
zero. This prompts an important question: how many software engineers or
data scientists are needed to develop the next version of a leading
smartphone? Probably the same or fewer than the last version as
operational efficiencies in these now maturing business models take hold.
This dynamic has, in part, led to an unprecedented wave of nearly 670,000
layoffs across more than 2,000 technology companies over the last two
years, including a significant number from the “Magnificent 7” (Apple,
Microsoft, Google, Amazon, NVIDIA, Meta Platforms, and Tesla).
The column chart shows the number of tech workers laid off each month
from March 2022 through January 2024. Layoffs were relatively low
until November 2022, the beginning of a six-month period during which
layoffs peaked at 107,760 in January 2023. Monthly layoffs have
declined since then, but remain elevated relative to levels before
Source – TrueUp
With intangible growth’s stranglehold on high-caliber technology talent
abating, we believe this provides a boon for value companies where data
science has had low or no penetration – which is the lion’s share of the
index. Value companies that are best able to capture and retain talent and
are pragmatic in their adoption of technology solutions going forward are,
in our view, likely positioned to see improvements in their earnings in
the years ahead. This growth resurgence will likely help reignite the
“animal spirits” driving earnings multiples higher, and thus returns, for
Our read of the investment narrative over the last several decades has
been one where the market has seemingly self-segregated into two distinct
investment groups – value or growth. We believe this shift, coupled with the
dynamics noted above, has now set the table for patient and nuanced
investment in these seemingly “left-for-dead, unimaginative,
non-innovating, and stuffy old economy businesses” that, ironically, have
the most to gain from leaning into and upgrading their intangible
assets – such as human and social capital, brand equity, intellectual
property, and network effects, among others.
We believe investors who are willing to expand their traditional
investment toolset to incorporate non-traditional, extra-financial factors
that feed growth stand to reap superior returns over time. So, as Mark
Twain noted to the newspaper upon reading his own obituary, “the reports
of my death have been greatly exaggerated,” we believe that value is not
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