2.6.2 Value Factor

The underlying logic

Value investing rests on the idea that markets periodically overreact, both to bad news, pushing some fundamentally sound companies to unreasonably cheap prices, and to good news, pushing some popular companies to unreasonably expensive ones. A value strategy systematically buys the former and generally avoids the latter, betting that prices eventually correct toward something closer to underlying fundamentals.

The value factor selects stocks that are cheap relative to their fundamentals: low price-to-earnings, low price-to-book, or high earnings yield. The premise, supported by decades of academic research led by Fama and French, is that the market systematically overprices glamorous growth stocks and underprices dull, out-of-favour companies. Over long periods, the cheap stocks as a group have outperformed the expensive ones, generating what is called the value premium.

The economic explanation is debated. One view holds that value stocks are cheap because they are genuinely riskier (weaker balance sheets, cyclical businesses, uncertain outlooks) and the premium is compensation for bearing that risk. Another view holds that it is a behavioural anomaly: investors overpay for exciting growth stories and underpay for boring businesses, creating a persistent mispricing. Both explanations may contain truth, and the practical implication is the same: a disciplined value approach has historically been rewarded, but only over long periods.

Why it has periods of real struggle

During periods when growth and momentum are strongly favoured by the broader market, often coinciding with low interest rates and high optimism about future earnings, value stocks can underperform meaningfully and for a genuinely extended period, sometimes lasting the better part of a decade before value leadership eventually reasserts itself.

The value factor had a painful decade-plus stretch of underperformance globally from roughly 2010 to 2020, during which growth stocks (particularly US technology) dominated. In India, the story was similar: quality-growth stocks massively outperformed traditional value metrics. Many investors and commentators declared value investing dead. This is a recurring pattern in factor history: extended underperformance leads to abandonment, which is precisely what creates the next cycle of value outperformance as the unloved stocks become even cheaper and the loved stocks become even more expensive.

How to hold a value tilt sensibly

A value tilt is best approached as a long-term structural allocation held through a full market cycle, not as a short-term tactical bet to be abandoned the moment it underperforms for a year or two, since that underperformance has historically been a normal, expected part of how the factor plays out over time.