LO 63.1: Describe the process of value investing, and explain reasons why a value

LO 63.1: Describe the process of value investing, and explain reasons why a value premium may exist.
Risk premiums are driven by factors. Econo my-wide (i.e., fundamental-based) factors such as inflation, volatility, productivity, economic growth, and demographics drive risk premiums. Additionally, factors related to tradeable investment styles such as momentum investing, value investing, and investing based on firm size drive returns.
A companys book value (i.e., net worth) per share is equal to total assets minus total liabilities divided by shares outstanding. It indicates, on a per-share basis, what a company would be worth if it liquidated its assets and paid off its liabilities. Value stocks have high book-to-market ratios while growth stocks have low book-to-market ratios, where market indicates the companys stock price. An investment strategy that is long value stocks and short growth stocks is called a value-growth strategy.
Historically, value stocks have significantly outperformed growth stocks. One dollar invested in a value-growth strategy in 1963 would be worth more than $6 around 2012, with a peak value of nearly $8 in 2006 and 2007. During the more than 40-year period, value stock returns experienced a sharp downturn during the tech boom, during the late 1990s, during the financial crisis in 2007-2009, and again in 2011. Overall, however, value investing appears to work. Are returns higher than growth investing returns due to a systematic factor? Alternatively, is there a value risk premium? Risk factors offer premiums to investors to compensate them for bearing losses in bad times, like the late 1990s and 20072009. Rational and behavioral explanations for the value premium will be discussed in detail in LO 63.3.
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Topic 63 Cross Reference to GARP Assigned Reading – Ang, Chapter 7
M a c r o e c o n o m ic Fa c t o r s

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