Friday, November 15, 2019

Picking the wrong measure for value or growth is costly

There are a number of ways to measure or rank value and growth stocks. Unfortunately, if an investor chooses the wrong ranking metric, he will be severely penalized. Apply the concept of value and growth to the wrong country or sector and an investor will also be penalized. The value factor or risk premia is time-varying. The measures to find the value factor will vary. Value in one country may not exist in another at the same time. Making the value or growth decision needs careful analysis and some application of diversification.

For value, there are three major measures, price to book, price to earnings, and dividend yield. Value investors want a low price to book value. There is a preference for low P/E ratios, and high dividend yields. Each have unique problems which make them difficult to apply to all stocks. Dividend yield cannot be applied to all stocks because many stocks do not issue dividend. The book value of stocks in some industries is not easy to measure, and the P/E for stocks will differ across region and industry. The same argument can apply to growth stocks where earnings per share growth or sales growth may show wide dispersion across countries and industries.

Investors are also affected by value and growth decisions for different countries and regions. Value over the last three months has been positive for the US, Europe, Japan, and developed markets, but a problem for emerging markets. Projected earnings per share growth was problematic for developed, US, and European markets, but positive for Japan and EM. Value returns have been shown to be sensitive to different points in the business cycle. If country business cycles are not synchronous, then the value factor will not be correlated.

Investors will have to diversify across measures for value and growth as well as across countries and regions to get a smooth value return. Investors can also make focused decisions on what is the best measure based on behavior of other investors or point in the business cycle, but this is a difficult prediction problem. There is not a single value or growth stock decision, so there is no simple answer when someone says they want a value or growth tilt. 

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