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The value factor is the oldest and most studied anomaly in finance. Benjamin Graham and David Dodd articulated the concept of buying stocks below their intrinsic value in their 1934 text "Security Analysis." Academic evidence from Fama and French (1992) showed that stocks with high book-to-market ratios earned significantly higher returns than growth stocks over the 1963-1990 period. The value premium has been documented across international markets, different time periods, and even other asset classes like bonds and currencies.
Value can be measured through multiple lenses. The classic academic metric is price-to-book ratio, but practitioners increasingly prefer earnings-based measures like price-to-earnings, enterprise value-to-EBITDA, and free cash flow yield. Composite value scores that combine multiple metrics tend to be more robust than any single measure. The choice of value metric matters: P/E ratios work well for profitable companies but fail for loss-making firms, while EV/EBITDA provides a more capital-structure-neutral comparison.
The economic explanation for the value premium remains debated. The risk-based explanation argues that value stocks are fundamentally riskier: they tend to be companies in financial distress, facing declining margins, or operating in challenged industries. Investors demand higher returns for holding these uncomfortable positions. The behavioral explanation argues that investors systematically overpay for glamorous growth stories and underpay for boring, distressed companies due to extrapolation bias and the preference for lottery-like payoffs.
Value investing experienced a historically difficult period from roughly 2017 to 2020, when growth stocks (particularly mega-cap technology companies) dramatically outperformed. The value spread, which measures the valuation difference between cheap and expensive stocks, reached extreme levels not seen since the dot-com bubble. Some researchers argued that low interest rates structurally favored long-duration growth stocks, while others maintained that the spread represented a mean-reversion opportunity.
Implementing value strategies requires careful attention to several practical issues. Value traps, stocks that are cheap for good reason, are the primary risk. Screens should incorporate quality filters to exclude companies with deteriorating fundamentals. Sector neutrality is also important: naive value screens often concentrate in a few deep-value sectors like financials and energy, introducing unintended sector bets. Finally, turnover and transaction costs must be managed, as value strategies with short holding periods can see much of their gross alpha eroded by trading costs.