In 1992, Chicago Booth’s Eugene F. Fama and Dartmouth’s Kenneth R. French rigorously demonstrated that value stocks, especially small-value stocks, had a statistically significant edge over growth stocks and the market as a whole. This finding cemented the idea that stock risk is multidimensional and that investors will require compensation for bearing risks associated with small stocks, value stocks, and so on. It also sparked a search for priced risk factors.
Now Fama and French have revisited the subject and find that the value-stock edge has shrunk dramatically since 1991.
Investors have long shown interest in value stocks—as early as 1934, the late economists Benjamin Graham and David L. Dodd, in their classic work Security Analysis, wrote that the job of the securities analyst was “the discovery of discrepancies between the intrinsic value and the market price [of a security].” Scholars and practitioners have long noted that value stocks, which have high book-to-market ratios, outperform growth stocks, which have low book-to-market ratios. A high book-to-market equity ratio means the firm may be distressed and is judged by the market to have relatively poor earnings prospects.
But has the edge that Fama and French demonstrated dulled? The S&P Value Index has underperformed the S&P 500 over the past 10, 15, and 20 years.
Fama and French don’t speculate as to why the value premium has shrunk, but they observe: “If investors do not judge that value stocks are, on some multifactor dimension, riskier than growth stocks, discovery of the value premium should lead to its demise.” This would be consistent with the efficient-market hypothesis and fit into a more general trend of academic research destroying stock-return predictability postpublication, as documented by Georgetown’s R. David McLean and Boston College’s Jeffrey Pontiff.
To assess whether the value premium has shrunk, Fama and French constructed seven portfolios—big value, small value, and market value; big growth, small growth, and market growth; and the market as a whole. Then they compared the value premium—measured as one of the three value portfolios’ returns in excess of the market return—for the July 1963–June 1991 time period from their 1992 paper with the value premium for the July 1991–June 2019 time period. Adding this second 28-year period allowed them to retest the influential findings of their 1992 paper using an equally long time period.
They estimate that the big-stock value premium declined from 4.3 percent per year (1963–1991) to 0.6 percent per year (1991–2019) while the small-stock value premium declined from 7 percent per year to 4 percent per year. Average value premiums were larger for 1963–1991 than 1991–2019, they write.
Fama and French found that, during the earlier time period, the value premium was a more consistent, moderately positive number, allowing them to estimate it with statistical confidence. In recent years, however, greater volatility of value-stock returns widened the range of plausible premiums—including, for the first time, negative estimates—and blurred the picture. “The declines from 1963–91 to 1991–2019 in average premiums for the value portfolios seem large, but statistically they are indistinguishable from zero,” they write. In particular, they are unable to reject both that the value premium is still as large as it has been historically and that the value premium has been zero in recent years.
In addition, growth stocks, which seem to get the most media attention, showed no edge over the market. “Average premiums in excess of Market for the three growth portfolios are small and indistinguishable from zero for 1963–2019 and for the 1963–1991 and 1991–2019 half-periods,” they write.
Until more data are available to enable academics and practitioners to draw statistical conclusions, the debate will continue over whether the value premium has disappeared. In the meantime, the strong underperformance of value stocks relative to the market during the March 2020 stock market crash will add fuel to the fire of the value-premium debate.
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