By Jeffrey J. Brown, MD MBA CFA CFP®
Investing can be analogous to baseball. The better team does not win every inning. In fact, good teams lose nine-inning games regularly and even great teams have losing streaks of several games in a row during a winning season. Our approach to investing involves emphasizing equity premiums that have historically provided higher returns over long time periods. While we expect these equity premiums to pay off in the long run, we know that results will vary from inning to inning and game to game.
Three equity premiums, referred to as the size, value, and profitability premiums, have been associated with higher stock returns. Historically, small companies have outperformed large companies, value stocks have outperformed growth stocks, and highly profitable companies have outperformed less profitable companies. In constructing our client portfolios, we overweight each of these equity premiums in striving to improve portfolio performance over time.
The illustration below reviews the performance of the equity premiums over rolling ten-year periods from 1973 to 2019.[1] The first row shows that U.S. stocks outperformed treasury bills in 38 ten-year periods since 1973 with only 9 losing periods.
The second row shows the value premium, which has recently been on a long losing streak leading some pundits to question if the value premium is dead. However, despite the recent underperformance, U.S. value stocks have beaten growth stocks in 36 of 47 ten-year periods since 1973. While growth stocks have been the recent winners, historical precedence suggests that value stocks will have eventually have their day in the sun again.
How about the size premium? As shown above, small cap stocks had a losing streak throughout most of the 1990s and have also underperformed in the most recent ten-year period. Nevertheless, small cap stocks beat large caps in 33 of the past 47 rolling ten-year periods. Despite their recent woes, small caps outperformed large caps by an average of 4.08% per year from 2000 to 2019.
The profitability premium has had the most impressive run. After a few early ten-year periods where high profitability companies underperformed, they have had a consecutive winning streak of 35 ten-year periods since 1984.
Here is the overall record of the equity premiums over 47 ten-inning games (ten-year periods) since 1973:
Value premium: 36 – 11
Size premium: 33 – 14
Profitability premium: 41 – 6
In baseball, no team goes undefeated. Similarly, in investing, equity premiums have their ups and downs and you must weather the occasional losing streak to reap the long-term benefits.
[1] Historical Performance of the US Equity Premiums: US Stocks, Rolling 10-Calendar Year Performance Periods. Dimensional Fund Advisors. 2020. [Past performance does not guarantee future results.]