The Value-Stock Premium Is Shrinking

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.