Reconsideration of Value Investing: Evaluation Based on Perfect Foresight

Abstract

Japanese equity value investing used to be known for its stable investment return that was rarely observed elsewhere in the world. However, similarly to the global decline in value investing, Japanese equity value investing, which has also fallen into a difficult situation. This article examines the past and current performance of value investing based on corporate earnings. The results of our study demonstrate that (1) from 2010 onward, even if a stock is a value stock based on both forecasted and realized earnings, the discount in valuation has not been subsequently corrected and (2) on the other hand, price formation in response to changes in realized earnings has functioned properly in all decades we examined. However, from 2018 onward, excess return was impossible to obtain both in Japan and in the U.S. even for stocks that are value stocks based on realized earnings or value stocks whose future earnings would increase. Although price formation of value stocks in the market has functioned correctly in the long run, we found that the pricing mechanism of the stock market has not worked properly in recent years. Therefore, the stock market may have been dysfunctional in recent years.