The Best Investment Writing Volume 5: Jack Vogel, Alpha Architect - Value Investing: An Examination of the 1,000 Largest Firms

Episode Summary

Executive Summary: Jack Vogel of Alpha Architect examines value investing's performance among the 1,000 largest U.S. firms from 1979 to 2020. He shows that while popular Russell 1000 indices suggest growth beats value, a simple price-to-earnings split reveals value outperforms growth by about 3% annually over 42 years. However, value can underperform for extended periods, as seen in the past decade and especially during the 2020 pandemic. Vogel emphasizes that value investing is not a free lunch and requires patience and conviction.

Main Topics: Value Investing Definition and Rationale (Priority: 5/5): Value investing involves buying stocks cheap relative to fundamentals like earnings. The strategy works due to risk or mispricing, but recent underperformance has led to claims of its death. Russell 1000 Index Performance vs. Simple PE Split (Priority: 5/5): The Russell 1000 Value index underperformed its Growth counterpart from 1979-2020, but a simple PE-based split of the 1,000 largest firms shows value beating growth by ~3% annually. Methodology of Value Measurement (Priority: 4/5): Vogel critiques the Russell methodology (using book-to-market, earnings growth forecasts, sales growth) and contrasts it with a straightforward PE multiple approach, which yields different results. Long-Term Value Premium Persistence (Priority: 4/5): Over 42 years, value outperforms growth across various portfolio splits (terciles, quintiles, deciles), with spreads widening as the tilt intensifies. $100 in value grows to ~$16,000 vs. ~$6,000 in growth. Recent Underperformance and Risks (Priority: 5/5): Value has struggled in the past 10 years, especially in 2020 (pandemic), with a 50% return differential favoring growth over seven months. This highlights that value is not a free lunch. Investor Psychology and Strategy Alignment (Priority: 3/5): Vogel categorizes investors into camps (Vanguard, dividend, value, growth) and suggests matching portfolios to personal comfort and trust in the process to endure periods of underperformance.

Key Arguments: Value investing works over long periods but can underperform for extended stretches, which is necessary for the premium to persist. The Russell 1000 indices' construction methodology (using book-to-market, earnings growth forecasts, sales growth) differs from simple PE splits, leading to misleading conclusions about value's death. A simple annual rebalance of the 1,000 largest firms into cheap and expensive halves based on PE yields a 3% annual value premium over 42 years, with $100 in value growing to $16,000 vs. $6,000 in growth. More extreme value tilts (deciles vs. halves) produce larger spreads (6% vs. 3%), but also greater volatility and drawdowns. Value's recent underperformance (e.g., 50% differential in 2020) is consistent with historical patterns and does not invalidate the long-term strategy. Investors should align with a strategy they can trust through cycles, as no approach works all the time.

Data Points: Russell 1000 Value vs. Growth (1979-2020): Value underperformed growth over the entire period - Using Russell 1000 indices, value lost to growth from Jan 1979 to Jul 2020. 10-year annualized returns (ending Jul 2020): Russell 1000: 13.85%, Value: 10%, Growth: 17% - Value underperformed growth by ~7% annually over 10 years. Value vs. Growth spread (simple PE split, 1979-2019): 3% annual premium for value - Cheap half of 1,000 largest firms returned 13.16% vs. expensive half 10.39%. Compounded growth of $100 (1979-2019): Value: ~$16,000, Growth: ~$6,000 - Illustrates the power of 3% annual compounding over 42 years. Spread by portfolio split (1979-2019): Terciles: 4%, Quintiles: 5%, Deciles: 6% - More extreme value tilts yield larger premiums. 2020 performance (Jan-Jul 2020): Most expensive quintile: +25%, Value quintile: -25% - 50% return differential favoring growth during the pandemic. Updated long-term premium (1979-Jul 2020): Value still outperforms growth by over 2% annually - Even including 2020's severe underperformance, value maintains a premium.

Pivotal Quotes: "Value investing is a simple concept: trying to buy stocks trading at lower multiples of earnings or fundamentals. In the past, value beat growth investing, but it will not work all the time." — Jack Vogel: Conclusion of the episode, summarizing the essence and reality of value investing. "The longer I've been in the investment industry, I've noticed that people tend to fall in different camps or religions when it comes to investing." — Jack Vogel: Introducing the idea that investor psychology and strategy alignment are crucial for long-term success. "This is not a free lunch. This is not guaranteed and it is not a free lunch." — Jack Vogel: Emphasizing that value investing involves risk and can underperform, which is necessary for the premium to persist.

Implications: Investors should not abandon value investing based on recent underperformance; long-term data supports its persistence. However, they must tolerate significant drawdowns and align with a strategy they can trust. Advisors should match clients to suitable approaches to avoid panic selling during downturns.