Value shares will easily outperform growth stocks over the next 10 years, according to Vanguard's Investment Research Group.
The conclusion is drawn in a paper from the group titled Value versus growth stocks: The coming reversal of fortunes released earlier this month.
"We expect value to outperform growth over the next 10-year period by as much as 5% to 7% per year, and perhaps by even more over the next 5 years," the report read.
The research was based on US markets, which the fortunes of Australian equities closely correlate to.
The four authors, Kevin DiCiurcio, Olga Lepigina, Ian Kresnak and Dr Joseph Davis, acknowledged that growth has completely outplayed value over the last decade.
But this is historically unusual.
"Over the last 10 years, US growth stocks have outperformed US value stocks by an average 7.8% per year," said the report.
"[However,] the value factor, as defined by Fama-French, has on average outperformed growth over 10-year time horizons going back to 1936."
Their analysis showed legitimate reasons for growth's dominance in recent years — low inflation, near-zero interest rates, corporate profits growth, and share market volatility.
But now they believe that narrative has been "oversold" — and it's time for value's revenge.
Post-COVID return to 'fair value'
The tide is about to turn, say the report's authors.
"Growth and value appear to be at the upper and lower bounds of their respective fair value to market estimates," the report read.
"Based on the historical performance of the models, deviations from fair value typically revert to fair value over time."
The other big driver is the rise of inflation back to more historically standard levels.
"If the [post-COVID] recovery were to stall meaningfully (or reverse) and neither inflation nor corporate profits accelerated, there is a risk that growth could continue to outperform," the study stated.
"We expect a gradual rise in fair value over the next 5 to 10 years as long-term inflation measures begin to normalise to our 2% target, real interest rates rise, and corporate profit growth rates increase amid the COVID-19 recovery."
Return forecasts for value and growth shares
Over the next 5 years, the Vanguard study predicts value stocks will outperform growth by between 9% and 13%. That will moderate to 5% to 7% winning margin over the next decade.
"Investors who allocate their entire equity portfolio to value can expect average annualised returns of 4.3% to 7.3% over the next decade, versus 3% to 5% for the broad US equity market."
The big question mark over this forecast is how much longer the market will reward growth companies for research and development spending.
But the report's authors reckon this has already been priced in.
"While we do not have an informed view on the expectation for future R&D spending by growth companies, we can say that current valuations of growth relative to the broad market are already priced to reflect the most optimistic corners of the distribution," the study read.
"Therefore, it is not unreasonable to believe that, even if investors continue to reward this behaviour, less upside potential remains."
