Clairvoyant Value and the Growth/Value Cycle

Abstract

The concept of Clairvoyant Value, introduced in Arnott, Li and Sherrerd (2009), allows us to explore how the market prices in future growth expectations, across securities, and over time. In this paper, we find both concurrent and predictive links between the intertemporal change in the Valuation Dispersion - the relative valuation gap between growth and value stocks - and the observed growth/value “cycle” in the market. On average, that dispersion is twice as wide as subsequent financial results would justify - the market historically has overpaid for growth. Also, historically, a wide dispersion of valuation multiples tends to precede a period of exceptional performance for value stocks relative to growth stocks. Finally, we address the total wealth effect of investing in a Clairvoyant Value portfolio. Clairvoyance on a company’s future business prospects is valuable, but perhaps a bit less so than most investors might surmise.