Sunil Wahal, Ph.D.
Consultant to Avantis Investors®
While stocks generally have done well over the last decade, the performance of growth stocks has been particularly strong. For investors looking for guidance about their relative prospects going forward, stock valuations may provide some insights.
Exhibit 1 shows that since 2010, growth stock valuations have increased—in some cases significantly more than value stock valuations. As an example, the price-to-book ratio (P/B) of large-cap growth stocks was 7.8x as of the end of 2019—a 113% increase since 2010. By comparison, the P/B ratio of large-cap value stocks increased 32% over the same period.
Other valuation measures display similar trends. Exhibit 2 compares several common valuation metrics, and all show that growth stock valuations, particularly in the large-cap universe, are significantly higher today than in 2010.
The difference between valuations of value and growth stocks—called the valuation spread—may provide insights into subsequent return differences between value and growth stocks.
In Exhibit 3, we summarize our experiment. We look at historical monthly valuation spreads between value and growth stocks and split them into two buckets: below median and above median. We then take the subsequent five-year return difference between value and growth indices for each month in the sample and calculate the average of the five-year periods in each bucket. Data show that periods following above-median valuation spreads experienced better future relative performance for value versus growth stocks.
This material has been prepared for educational purposes only. It is not intended to provide, and should not be relied upon for, investment, accounting, legal or tax advice.
The information in this document does not represent a recommendation to buy, sell or hold security. The trading techniques offered in this report do not guarantee best execution or pricing.