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Quality Enhances Value for Investors After Market Crises

19 July 2021
2 min read
James MacGregor, CFA| Chief Investment Officer—US Small and Mid Cap Value Equities; Head—US Value Equities
Cem Inal| Chief Investment Officer—US Large Cap Value Equities; Portfolio Manager—Global Real Estate Securities
Dennis Stakhov| Senior Quantitative Research Analyst—US Value Equities
Highest-Profitability Value Companies Have Performed Best Through Market Shocks
Higher profitability value stocks are shown to perform better than value stocks overall based on five market shocks since 1990. But performance hasn’t been as strong yet in the COVID-19 recovery.

Past performance and current analysis do not guarantee future results.
Highest free-cash-flow yield is the highest tercile of companies in the Russell 1000 Index based on free cash flow/share price. Within this group, the highest profitability is the highest tercile of companies based on free cash flow/assets. The five episodes chosen for analysis are two-year periods, beginning six months before the trough in a market downturn of at least 10% from the beginning to the end of a quarter. These include the US savings-and-loan crisis, measured from March 1, 1990; the dot-com bubble, measured from September 1, 1999; the September 11, 2001, attacks in the US, measured from March 1, 2001; the global financial crisis, measured from August 1, 2008; and the European debt crisis, measured from March 1, 2011. The COVID-19 crisis is measured from September 1, 2019, through May 31, 2021 (three months shorter than other periods shown).
As of June 30, 2021
Source: Bloomberg, FTSE Russell and AllianceBernstein (AB)

Market crises and macroeconomic recessions typically create fertile ground for value stocks to outperform in a recovery. Our research suggests that higher-quality stocks with strong profitability credentials can deliver even better results after a crisis.

Since value stocks are widely perceived as higher-risk assets, they typically benefit from risk-on market environments after a market shock. Value stocks are also more prevalent in sectors that are more sensitive to macroeconomic cycles, such as industrials or materials, which tend to shine when GDP growth recovers. Indeed, the Russell 1000 Value Index surged by 37.9% from November 2020 through April 2021, as COVID-19 vaccine rollouts inspired confidence in the nascent recovery.

However, after value stocks underperformed in the second quarter, some investors wonder whether the value recovery has run its course. We think there’s more to come, and a focus on high-quality stocks should be particularly rewarding over time.

Quality Focus Bolsters Return Potential

To gauge the potential, we looked at five major shocks since 1990, when the market fell by at least 10% from the beginning to the end of a quarter. In each, we analyzed the performance of US value stocks, defined by the tercile of companies with the highest free-cash-flow (FCF) yield, as well as the highest-quality group within that tercile, based on the FCF/assets ratio. Performance was measured over a two-year period, beginning six months before the market trough to account for the fact that it’s almost impossible for investors to time a downturn or inflection point with precision.

On average, value stocks returned 14.4% annualized (Display, left). By adding a quality filter to that group, shown in the uppermost bar, investors would have enjoyed a 15.9% annualized return over the same period. Both groups outperformed the Russell 1000 Index, which was flat on average. What’s more, volatility for the highest group was also slightly lower than the market on an equal-weighted basis, meaning investors’ risk-adjusted return would have been better too. 

More to Come?

So, how have higher-quality value stocks done so far in the COVID-19 recovery? Today, relative returns for the highest-profitability group are still far behind the average seen in previous crises, even after the rebound earlier this year (Display, right).

To be sure, every recession and market crisis has unique features. But we believe today’s post-COVID-19 market provides a large opportunity for value investors. Value stocks still trade at a deep discount to growth peers. And there is still plenty of uncertainty about the path to normal in many industries. In this environment, we believe attractively valued companies with higher-quality businesses and sustainable cash flows are well positioned to deliver outsize returns as the world economy gradually returns to normal. 

The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AB portfolio-management teams. Views are subject to revision over time.

About the Authors

James MacGregor was appointed Chief Investment Officer of US Small and Mid Cap Value Equities in 2009. In this role, he acts as the lead portfolio manager for AB’s US Small and Mid Cap Value strategies. MacGregor was appointed Head of US Value Equities in 2019, responsible for all US Value portfolios in the areas of business management and talent development. From 2009 to 2012, he also served as CIO of Canadian Value Equities. From 2004 to 2009, MacGregor was director of research for Small and Mid Cap Value Equities, overseeing coverage of companies for the Small Cap and Small/Mid Cap Value services. He started as a research analyst covering a wide number of sectors for those same services. Prior to joining the firm in 1998, MacGregor was a sell-side research analyst at Morgan Stanley, where he covered US packaging and Canadian paper stocks. He also serves as a board member and volunteer for Xavier Mission, a charitable organization that provides basic services and opportunities for empowerment and self-sufficiency to New Yorkers in need. MacGregor holds a BA in economics from McGill University, an MSc in economics from the London School of Economics and an MBA from the University of Chicago. He is a CFA charterholder. Location: New York

Cem Inal was appointed Chief Investment Officer of US Large Cap Value Equities in 2020, after serving as portfolio manager of US Large Cap Value Equities from 2016 until 2019. He has also served as Portfolio Manager of Global Real Estate Securities since 2023. Inal was previously a senior research analyst and leader of the technology sector. He also co-managed the International Small Cap Value service from its inception in 2014 until 2016. Before joining the firm in 2003 as a research analyst, Inal was a vice president at fusionOne, a communications software provider. Prior to that, he was an engagement manager at McKinsey & Company and a research engineer at Mitsubishi Electric. Inal holds a BSE in electrical engineering from Princeton University and an MBA in financial engineering from Cornell University. Location: New York

Dennis Stakhov is a Vice President and Senior Quantitative Research Analyst for US Value Equities. Prior to joining AB in 2018, he was a member of the quantitative strategies team at Columbia Threadneedle Investments. Stakhov holds a BA in mathematics from Hunter College and an MS in computational finance from Carnegie Mellon University. Location: New York

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