Momentum within value

As the economic recovery became visible in 2020, value stocks began to outperform growth stocks, and value ultimately led growth by a wide margin in the closing part of the year. We think that better growth prospects and more attractive valuations could be the impetus for a more sustained rally in value.


Fourth-quarter 2020 returns were decidedly in value’s favor, and while the rotation to value has been long awaited and impossible to predict, it should hardly be surprising. Discrete events—such as the Troubled Asset Relief Program announcement during the global financial crisis or the introduction of vaccines in today’s pandemic—often signal the beginning of long and enduring value rallies, especially when they follow the type of long, deep anti-value cycle of recent experience.

We believe results to date could signal the start of a long pro-value cycle. Several catalysts are aligning in value’s favor, the most visible of which are companies’ earnings growth as they recover from the pandemic-induced recession and the normalization of multiples that investors assign to those earnings.

The Q4 value rally in context

Value’s powerful fourth-quarter rally was driven in roughly equal parts by earnings-per-share growth and multiples expansion, the latter accelerating after the announcement of successful vaccines. However, the massive differential in earnings multiples between value and growth stocks that developed over the last three years was only minimally retraced: As of the end of 2020, value multiples still trailed growth by a wide margin. According to our research, multiples have historically mean reverted over time. If history is a prologue, we believe the rerating of value stocks is in its early days and could be a powerful contributor to value’s returns as this multiple differential normalizes.

Value's multiple has more ground to make up

Change in P/E, 12/31/16–9/30/20 vs. Q4 2020 (%)

Source: FactSet, Pzena, January 2021. Price to earnings (P/E) is a valuation measure comparing the ratio of a stock’s price with its earnings per share. Percentage change in P/E for the period 12/31/16 to 9/30/20 vs. Q4 2020 consensus estimate is as of 12/31/20. See important disclosures below for more information.


Earnings, on the other hand, have contributed the most to long-term returns, and we expect this cycle to be no different. The vast majority of value’s underperformance in 2020 came from a collapse in earnings, setting the stage for a powerful earnings recovery coming out of the downturn.

Recession hit value stocks hard

The unprecedented impact to the economy from the COVID lockdowns was particularly unkind to cyclical stocks, most notably in energy, financials, and travel-related businesses. The carnage, however, created a once-in-a-generation opportunity to buy market leaders with strong balance sheets and liquidity to survive the severe disruption. Stock selection, of course, has been crucial, as many companies faced—and continue to face—uncertain futures, including some with financial positions that might not survive a prolonged downturn. For a disciplined value investor, it was an opportunity to deploy capital into well-positioned companies that had been valued as if COVID would never end.

The disproportionate impact on earnings is stark. While the earnings of the Russell 1000 Growth Index are estimated to have risen by 6% in 2020, Russell 1000 Value Index earnings fell by 20%.1 What’s more, the earnings of deep value stocks—which we define as stocks that are priced significantly below their long-term earnings potential—fell by 21%. Similarly, outside the United States, earnings are estimated to have fallen by 5% for growth stocks, 21% for value stocks, and by 28% for deep value stocks.

So then, what might we expect as global economic activity recovers?

Earnings for value companies collapsed in 2020

Change in earnings (%)

Source: Bloomberg, FactSet, Pzena, 2020. Full-year 2020 earnings are based on consensus estimates as of 12/31/20. See important disclosures below for more information. 

Earnings recovery favors value stocks

Companies reacted to the operational challenges of COVID-19 the way they do to any crisis: by cutting costs, drawing down inventories, and suspending capital expenditures. Corporate reaction to the onset of COVID was swift, particularly among the cyclical companies most affected by the downturn. In our view, these aggressive actions, coupled with a rebound in economic activity, should provide significant operating leverage to sustain a strong earnings recovery over the next couple of years, especially among value stocks.

2020–2022 estimated earnings growth is faster among cheaper stocks

Compound annual growth rate (%)

Source: Bloomberg, FactSet, Pzena, 2020. Full-year 2020 earnings are based on consensus estimates as of 12/31/20. See important disclosures below for more information. 

Looking across the universe of U.S. stocks as of the end of 2020, the Russell 1000 Growth Index is expected to grow earnings at a 17% compound annual growth rate1 (CAGR) over the next two years and is trading at 27x 2022 estimated (2022e) earnings. The Russell 1000 Value Index is expected to grow earnings at 23% annually over the same period and is trading at only 15x 2022. Importantly, deep value is also expected to grow earnings at a 23% CAGR while also offering a significant opportunity for rerating, trading at just 11x 2022. Even this appraisal might be conservative since 2021e earnings for financials and energy stocks within the S&P 500 Index are 29% and 37%, respectively, below 2019 results, setting the stage for potential earnings beats from these two sectors, which represent a large portion of the cheapest stocks.

Similar dynamics are at play outside the United States. The MSCI ACWI ex-USA Growth Index is expected to grow earnings at a 26% CAGR over the next two years and now trades at 20x 2022e, while the MSCI ACWI ex-USA Value Index is expected to grow earnings at 20% and trades at 11x 2022e. Once again, deep value offers the best opportunity, with earnings expected to grow at a 28% CAGR while trading at just 8x 2022.

2022 estimated P/E multiples (x)  
    U.S. Non-U.S.
Growth   27.3 20
Value   15.2 10.6
Cheapest quintile   10.9 8.4
Source: Bloomberg, FactSet, Pzena, 2020. Full-year 2022 earnings are based on consensus estimates and pricing as of 12/31/20. See important disclosures below for more information.

Conclusion: we may be in the early stages of a long value cycle

At the end of the third quarter of 2020, we asked a simple question: If you’re not going to invest in value now, when will you? Vaccine announcements drove a dramatic turn to value in the fourth quarter, as investors saw a path to economic recovery. Given the length of past value cycles, the massive gap in multiples that has yet to normalize, and the prospects for earnings recovery, it certainly seems like an opportune time to turn to value and potentially benefit from what could be a long and enduring value cycle.

FactSet consensus earnings estimates.