That value investing adds to performance has been a theory since the days of Dodd Graham, promoted by the likes of Warren Buffett and cited by academia as one of the first challenges to the view that markets are efficient, whether “value” is measured by price-to-earning, price-to-book or dividend ratios. It has held up across markets and time periods. And it makes sense. A higher expected return is equivalent to a higher discount rate. Discounting future cash flows back to their present value at a higher rate, in turn, leads to a lower price and by extension a lower price ratio. There is also research showing the value variable is correlated to the economy and hence incomes. In other words, value stocks do worse when you need them to hold up the most — when your job is in jeopardy. Most investors should want a higher expected return to own them.

No wonder “value” is often considered a risk variable, but it also fits behaviorist’s views that markets overreact. Gene Fama and Ken French, the authors of the most referenced research around the value premium and yet believers in market efficiency, readily point out that much of the performance of their low price-to-book ratio portfolios comes from firms becoming more profitable and moving out of the value spectrum. But again, whether that behavior comes from consistently “learning impaired” investors (Fama and French’s label) who are constantly shocked at the turning fortunes of firms or by real undiversifiable risks is and likely always will be an open debate. The important take away is that book-to-value is an adequate but surely not the “right” measure of value, nor is any other single or combination measure of value. Still, they all work.