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Valuation Dividend – Q3 Strategy Letter

The 10 Yr. US Treasury yield ended the quarter flat at around 0.66%, though dipped to nearly 0.51% in early August. In July, headlines about rising Covid-19 infection rates in the US crowded the outlook for continued economic recovery, and fears were prevalent that a lack of fiscal support after the expiration of the extra unemployment benefits would put new strains on the US economy. With the US Treasury rates falling, the US dollar index (DXY) also crashed, losing nearly 4% of its value in July. As the quarter went on, better than expected 20Q2 earnings results, optimism about the availability of Covid vaccines in the foreseeable future, and generally positive news on consumer spending and net job gains have reinjected confidence in investors about the continued momentum of the US recovery. Despite the Fed’s pledge to keep interest rates low for longer than expected, the 10 Yr note yield jumped from the August low.

In the third quarter, dividend yield remained a detracting factor to alpha generation, with the top 20% stocks ranked by dividend yield in the R1000 underperforming the bottom 20% stocks by 870 bps (based on equal weighted return). Value continued to significantly underperform Growth, and IWD (iShare R1000 Value) lagged IWF (iShare R1000 Growth) by 763 bps in the quarter. In fact, IWD has underperformed IWF by nearly 36% year to date. Stunning? Indeed. Not surprisingly, when we examine the valuation attractiveness of a typical firm in the R1000 Value vs. R1000 Growth, we find Value to be materially more attractive than Growth. The charts below show the median valuation upside/downside relative to their standardized long-term average based on Applied Finance’ intrinsic value estimates. Also plotted are -1.5 (red) and +1.5 (green) standard deviation lines. (Please click here to access a more detailed discussion of Large Cap. Value / Growth Valuation Analysis by Applied Finance.)

When we examine the relative Value/Growth long-term relationship in the chart below (a higher percentage represents relative value attractiveness), we have a few observations:

▪ Value / Growth attractiveness looks stable most of the time (in the past 22 years)
▪ Moderate Value attractiveness during late 2008 into 2009
▪ Value began looking more attractive than growth recently, exacerbated by Covid-19, but not as extreme as during the Tech Bubble

*Data Source: Applied Finance Data 9/30/1998 – 8/31/2020
*All Median Valuation figures normalized to long-term average of each Index/Partition.
*Value/Growth partitions use Applied Finance MVIC criteria.

Growth’s superior performance this year, and in particular after March, is driven largely by technology stocks, though the tech rally has not yet been dubbed a bubble. From the late 1990’s, the technology industry as a whole has evolved from consisting of companies promising productivity improvements, and often under-delivering (Pets.com conveniently came to mind) to boasting firms that are slowly revolutionizing virtually every business and consumer experience. Many technology companies today have become the juggernauts of the global economy, generating enormous amount of revenues and profits. While we believe technology’s future is exciting and critical to global economic growth, with Growth’s (alas tech companies) valuation looking very rich relative to their historical norm, we as investors must remain vigilant and never be carried away by pure promises and excitement.

In the 3rd quarter of 2020, the Valuation Dividend returned 5.52%, vs. 5.59% for its benchmark Russell 1000 Value, on a total return basis. Since its inception on April 11 of 2012, the Valuation Dividend has returned 136.76%, outperforming the R1000 Value by 115 bps on an annualized basis.


  • Applied Finance, a thought leader in valuation and portfolio construction, is a true “value” investment management company.  Unlike the majority of firms today that focus on low multiples to define “value”, we define value as identifying companies trading below their intrinsic value.  Our Valuation Driven™ approach forms the foundation of our investment decisions...more


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