The value premium, and “value investing” in general, is the most familiar of these factors to most investors. The idea of value investing goes back to at least the Great Depression, when Benjamin Graham released his classic “The Intelligent Investor.” Warren Buffet, his student, is the world’s most famous value investor. The idea behind value investing is simple: “cheap” assets are a better deal than “expensive” assets and should outperform them in the long run. What’s a cheap asset? Say company A and company B both have stocks that sell for $20 a share. But company A earns $5 per share in profits and company B only earns $2 per share. Company A is a value stock: you can buy a share of its earnings for cheaper than company B.
Stocks that score high on the value factor have historically outperformed low-value-factor stocks in virtually every market studied by an impressive margin. The concept can also be extended to bond markets by comparing yields relative to credit-quality, currency markets by price relative to purchasing power parity, and commodities by price relative to producer price index.