Over time, valuation-oriented investment strategies should outperform the market; in other words, the better the valuation process, the better we expect them to perform. 
However, it has been a bleak few years for value investors. Contrary to long-term experience, highly-priced companies have outpaced their lowly-priced peers in almost all of the market, leading the performance gap between growth and value stocks to reach levels last seen in the late nineties’ tech bubble.
Managers have debated greatly the recent growth stock bull market, seeking to understand why fast-growing but expensive firms have been so unusually prized and whether this might continue. Three decades of investing show that, while value is cyclically out of favour, it is not “dead”.
This perspective enables us to focus on the silver lining around the recent value investing storm clouds: If our valuations are well-founded then their recent underperformance creates a store of latent value to be captured when the cycle turns.
Predicting when sentiment will shift is difficult. But, when such turning points have occurred in the past, they have created some of the best conditions for value investors.
A closer look at mispricing
By looking at the valuation and quality of companies’ fundamentals with investor sentiment on each stock, our proprietary valuation model prices more than 20,000 stocks around the world every day based on a systematic assessment of each company’s tangible and intangible assets, liabilities, and delivered and predicted fundamentals.
Comparing current market price with this assessment of fair value helps to identify undervalued stocks and perspective on mispricing.
The late nineties tech bubble
Most stocks trade close to our estimate of fair value. Exceptions, however, are clear, with none quite as exceptional as the dotcom bubble.
Market prices and fair values were relativity attractive until 1998. The end of 1997 saw 80 per cent of the Russell 2000 index traded within 50 per cent of its fair value.
As the bubble inflated in 1998, the ties binding price and value began to strain. Through 1999 close to 75 per cent of a variety of both large- and small-cap indices traded more than 25 per cent from our estimate of fair. 
When the bubble burst in March 2000, the darlings of the dotcom era came down to earth with such force that, had you bought several of these stocks at their peak, you would still be sharply below your purchase price. By contrast, stocks that had lagged during the bubble fared significantly better. This caused a sustained fall in mispricing, alongside a dramatic recovery in value strategies.
The recent growth stock bull market
In 2007, growth stocks posted their first annual out-performance over value since the tech bubble. Our measure of mispricing followed a similar path, with index weights in the most mispriced stocks falling sharply from 2000 to 2006 before rising again through the global financial crisis.
It was not until 2014 and 2015 that growth stocks definitively regained market leadership. After a short value rally in 2016, the growth stock bull market began in 2017 and has continued.
Our analysis shows that the degree of mispricing has risen across markets, sectors and capitalisation segments. At the end of June, prior to the revival in lowly-valued stocks in the third quarter, almost 15 per cent of the MSCI World index traded more than 50 per cent away from our estimate of fair value.
The biggest valuation opportunity in 20 years
In these elevated levels of mispricing we see the start of a favourable environment for valuation-oriented investors. Mispricing so far in 2019 is not at the same levels as in the late 1990s, we think they represent the biggest valuation opportunity in 20 years.
We believe value will recover, for two reasons.
Firstly, a long-term perspective reveals a high degree of cyclicality in the market’s preference for value and growth stocks. Particularly with the absolute level of mispricing ebbing and flowing on a multi-year basis. Should this pattern continue, then the current growth cycle would be likely to give way to an enduring period of value outperformance.
Secondly, we have a model that identifies undervalued companies that have gone on to outperform the market, and vice versa. While the model is not designed to be a market timing tool – investor exuberance can pull price far from a fundamentally justified fair value in the short term – historically, its effectiveness has been greater the larger the degree of mispricing.
In our view, this reflects the gravitational pull of company fundamentals on corporate fair values. The greater the discrepancy between price and the collection of these attributes, the more likely the stock is either artificially inflated or deflated and the greater the potential opportunity when investor sentiment shifts. The catalyst for capturing this opportunity can be hard to identify yet, history shows that it happens.
Managers’ dissections of why this hasn’t occurred during the recent market typically focus on certain elements of the macro- and microeconomic environment that may have delayed overvalued stocks’ day of reckoning. First, the past few years have witnessed a seemingly unprecedented degree of disruption: new businesses and business models have emerged with transformational consequences for the global economy. Second, record low interest rates have enabled these firms to sustain unprofitable enterprises for much longer than usual. In the low-growth world that has followed the crisis, the premium that investors are willing to pay for potential growth is structurally higher, making high valuations less of an issue than before.
While all the above seem like reasonable assessments of why growth stocks have outperformed in recent years, we doubt that they represent sustainable justifications for why value no longer matters. At some point, valuation always matters. We believe that the sharp shift in favour of value in September may have been driving the rotation: investors acknowledging, and beginning to address, unsustainable levels of mispricing.
The elevated levels of mispricing we see in today’s markets are the most likely driver of the next transition and represent a welcome silver lining for value investors after several bleak years.
Jonathan White, head of client portfolio management, and Euan Mackay, client portfolio manager, at AXA IM Rosenberg Equities. The views expressed above are their own and should not be taken as investment advice.