By |Published On: June 11th, 2019|Categories: Research Insights, Factor Investing, Value Investing Research|

We built a simple tool recently to review so-called value spreads over time. (1)

This tool maps out the median valuations for the top decile and bottom decile “cheap stock” portfolios (e.g. EBIT/TEV or sales/price).

Why might this be useful?

This tool allows one to identify the “valuation” spread between the cheapest stocks and the most expensive stocks in the universe. Some research suggests this can be a useful prediction device.

The analysis to build the data works as follows:

  • Identify Universe: Top 1500 stocks by market cap (US and EAFE)
  • Identify Valuation: Calculate a valuation metric (e.g., EBIT/TEV) for all firms in the universe
  • Decile Splits: Sort the 1500 stocks into 10 buckets, 150 stocks each, equal-weight, rebalance monthly
  • Calculate Median Valuation: For each decile, calculate the median valuation metric (e.g., EBIT/TEV)
  • Plot the data

We create the following time series (assuming EBIT/TEV is the value metric):

  • US Value = Top Decile EBIT/TEV (1)
  • US Glamour = Bottom Decile EBIT/TEV (10)
  • US Spread = US Value – US Glamour
  • EAFE Value = Top Decile EBIT/TEV (1)
  • EAFE Glamour = Bottom Decile EBIT/TEV (10)
  • EAFE Spread = US Value – US Glamour

Here is a chart of the spreads since 1992 for the US and EAFE. You can dig in to the tool for the raw data and additional breakouts on the data.

Source: https://alphaarchitect.com/visualfactors/

Conclusions

Spreads aren’t crazy and fairly in line with historical norms. Surprising.

References[+]

About the Author: Wesley Gray, PhD

Wesley Gray, PhD
After serving as a Captain in the United States Marine Corps, Dr. Gray earned an MBA and a PhD in finance from the University of Chicago where he studied under Nobel Prize Winner Eugene Fama. Next, Wes took an academic job in his wife’s hometown of Philadelphia and worked as a finance professor at Drexel University. Dr. Gray’s interest in bridging the research gap between academia and industry led him to found Alpha Architect, an asset management firm dedicated to an impact mission of empowering investors through education. He is a contributor to multiple industry publications and regularly speaks to professional investor groups across the country. Wes has published multiple academic papers and four books, including Embedded (Naval Institute Press, 2009), Quantitative Value (Wiley, 2012), DIY Financial Advisor (Wiley, 2015), and Quantitative Momentum (Wiley, 2016). Dr. Gray currently resides in Palmas Del Mar Puerto Rico with his wife and three children. He recently finished the Leadville 100 ultramarathon race and promises to make better life decisions in the future.