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The Underestimated versus the Overhyped

We prefer value stocks since they outperform growth stocks in the long run. The outperformance is even more pronounced for small and mid cap companies.

The Ibbotson chart below, which spans nearly 40 years, clearly illustrates that “value” easily trumps “growth” for small, mid and large capitalization stocks over the long run. This is logical since by definition “value stocks” are cheap and are generally priced-off of historical results because they are growing more slowly. On the other hand, “growth stocks” are expensive and are price-off of anticipated results because their high growth rates are hyped by analysts and investment bankers.

Value stocks often exceed low expectations leading to positive surprises and outperformance. Conversely, growth stocks often miss high expectations leading to disappointment and underperformance. Value stocks eventually get recognized by investors and rise up to fair value, while growth stocks eventually loose their luster and revert back down to fair value. Value stocks’ outperformance is even more pronounced for small and mid cap companies, because they tend to trade at even bigger discounts due to illiquidity and lack of analyst coverage, as well as being able to achieve higher growth rates than larger companies.