Forget about the 1%’ers, look at the 10%’ers, says AllianceBernstein. They wrote an interesting blog post a week or so ago about the widening gap between in the rich stocks and the value stocks.
In the aftermath of last year’s market party, the most expensive quintile of global stocks now trades at 8.1 times book value, or almost four times higher than the global stock market as a whole—the second-highest premium since 1971 (Display 1). Earnings multiples are similarly hefty. Meanwhile, the cheapest quintile sells at 0.9 times book value, a 57% discount to the market and around its historical average in both absolute and relative terms. In the past, differences of this magnitude between the valuations of cheap and expensive stocks have heralded outsized value outperformance. Eventually, either the controversies that caused the disparity resolved themselves or cheap stocks simply became too enticing to resist.
Author Chris Marx notes that Consumer Cyclicals & Staples, Medical and Technology sectors are among the highest P/BV valuations and Financials, Housing and Utilities are among the lowest. Neither of those two facts should be all that surprising as those sectors typically exhibit such a split due to accounting treatment of assets and intangibles as well as valuation preferences regarding growth. However, I think his point is the magnitude of the gap.
Using Bloodhound’s AlphaFactor tool, we are able to quickly analyze factors contributing to performance. Bloodhound’s simulation engine queries our proprietary database of U.S. and Canadian stocks (and U.S.-listed ADRs) back to 1987. The “as-reported” and unadjusted dataset enables the recreation of real-world peformance free of survivorship bias and look-ahead bais. As such, we chose to look at the return profile of holding the richest and cheapest stocks. Rather than focus on book value which can be skewed by accounting treatment of tangible and intangible assets, we looked at forward P/E valuations. We compared portfolios of the highest forward P/Es against a portfolio of the lowest forward P/Es, each qualified by being listed on the NYSE or NASDAQ and greater than $1bn in market cap. We set up rules to buy the 100 highest (lowest) stocks, and held them for at least 30 days, and rebalanced the value amongst the portfolio once a month.
Due to the assymetric returns of the equity market, both strategies have positive geometric returns; however, the low P/E strategy has substantially outperformed the high P/E strategy over the the last 28 years. In the last eleven years, the S&P 500 has finished in the black in all but one (2008), and the high P/E strategy underperformed in 50% of them, while the low P/E startegy only underperformed in one. Neither strategy did particularly well during the high correlation period of 2008. Both strategies massively underformed the S&P 500.
The correlation between the two strategies are stong (87% on a yearly basis, and 89% on a monthly basis), their return profiles are widely different. While high P/E is outperforming so far this year, low P/E outperformed for the 16 straight months ended December 2013.
As Bernstein points out, the widening gap in valuation may be tilting the field in favor of value stocks, but the field was already tilted.