Many empirical studies have shown that a value style approach to investing in Australian shares has consistently outperformed growth investing - and with less risk. Recent analysis by Nikko Asset Management Australia not only supports these findings but suggests that this anomaly is a permanent feature of the Australian share market.

There have been many studies on various equity markets which show that value has consistently outperformed growth. These studies include Basu (1977), De Bondt & Thaler (1985) (1987), Lakonishok & Vishny (1994), Fama & French (1992), and Arshanapalli, Coggin & Doukas (1998). Typically, these studies defined value stocks as those with low 'Price to Book' ratios or in some cases low 'Price to Historical Earnings' ratios.

Of course, this fact would come as no surprise to the many famous value investors, such as Warren Buffett and John Templeton, who have enjoyed enduring success with their share investments.

Australian market style indices produced by S&P/Citigroup, show that over the last 25 years (October 1989 to October 2014), value investing in Australia has outperformed growth investing in Australia.

During this period, value produced a return of 11.07% pa, while growth produced a return of 8.97% pa. This means that value outperformed growth by 2.10% pa.

In dollar terms, if AUD 1,000 was invested in the S&P/Citigroup Value Index during this 25-year period, it would have accumulated to AUD 13,793 by October 2014; whereas for growth, the amount would have been materially lower at AUD 8,555.

A cynic may argue that the only reason why value outperformed growth is because value shares are riskier than growth shares. Many value investors would disagree with this statement, and actually believe that value investing is actually less risky than growth. Most value investors would argue that they pay 60 cents for something that is worth $1, and as such there is a good margin of safety in the investments they undertake.

One measure of risk is the volatility of returns as measured by the standard deviation of returns. As table 1 shows, value has been less volatile than growth with a standard deviation of 13.44% pa versus 14.17% pa for growth.

Table 1: Value investing has outperformed growth and with less risk

Australia:
October 1989 to October 2014
S&P/Citigroup Value S&P/Citigroup Growth Difference S&P/Citigroup Broad Market Index (BMI)
Returns (% pa) 11.07 8.97 2.10 10.08
Standard Deviation (% pa) 13.44 14.17 -0.72 13.40
Historical Beta 0.97 1.03 -0.06 1.00

Source: S&P/Citigroup Broad Market Index, Nikko Asset Management Australia
Performance is gross of fees. Past performance is not an indicator of future performance.

Another measure of risk is beta, which is essentially a measure of market risk and strips out the impact of stock-specific risk which can be diversified away. As table 1 shows, value has had less market risk than growth with a beta of 0.97 versus 1.03 for growth.

This analysis thus shows that not only has value outperformed growth in the Australian share market by a significant margin, but it has done so with less risk.

How significant are these findings?

One way to measure the significance of a result, is to calculate a t-statistic. In this case, it is important to test how confident we can be that value will continue to outperform growth in the future. To calculate a t-statistic, the historical outperformance of value over growth, the standard deviation of this outperformance and the number of observations are required. Naturally, the greater the sample size, the more significant will be the result. The formula to calculate the t-statistic is provided below:

T-statistic = (outperformance/standard deviation of outperformance) x square-root (no. of observations)

As a general rule, a t-statistic of at least +1.0 is considered to be meaningful and +2.0 is considered be highly significant.

Our analysis of Australian value investing versus Australian growth investing over the same 25-year period showed a t-statistic of +1.5 (as shown in table 2). This implies a 94% probability that value will continue to outperform.

Table 2: The results are significant

Market Time period T-statistic of Value versus Growth Implied probability
Australia (S&P/Citigroup BMI) October 1989 to October 2014 +1.5 94%

Source: S&P/Citigroup Broad Market Index, Nikko Asset Management Australia
Performance is gross of fees. Past performance is not an indicator of future performance

Can this anomaly continue? Overall we can be confident, at least from a statistical perspective that value will continue to outperform growth in the Australian share market. Apart from the quantitative support, there are also qualitative factors, namely investor behaviour.

Time and time again, history has repeated itself with the various booms and busts of share markets, and speculative bubbles within the share market itself as investors chase the latest fads and 'fashionable' stocks. In each case, the markets have corrected themselves.

We only need to recall the Telecommunications/Media/Technology (TMT) boom of 2000 and its subsequent bust for a very dramatic example of when so-called growth and/or high beta stocks moved to stratospheric price levels, while solid companies with real cash flows were sold down heavily as investors chased the latest hot stock.

In each and every case, a great opportunity was created for those investors who stayed with value and did not get caught up in the hype. These opportunities will present themselves again well into the future due to the psychology of investors as inevitably, history will repeat itself again and again.

Simply investing in 'cheap' stocks is however not a wise investment strategy – many so-called value stocks are cheap for a reason. Intensive, fundamental research and an active approach to investing can help discerning investors identify stocks that offer true value and in the process avoid value traps.