Successful Value Investing: How You Measure and Target Value Matters

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While all value investing strategies share the goal of identifying undervalued stocks, there are actually many different ways to define value. Advisors trying to meet their clients’ goals may want to carefully examine how a given strategy measures value — and how the portfolio targets that value exposure.

Portfolio managers can use a range of value metrics, such as price-to-book, price-to-sales and price-to-cash flow. There’s ample academic research showing that each may effectively identify stocks that historically have provided a long-term return premium. But it’s important to remember that the value premium is a risk premium — and we believe that all investors should be compensated for the risks they take.

To avoid uncompensated risk in value investing, FlexShares recommends that advisors look for strategies that use:


Common value metrics gauge how cheap or expensive a stock is based on some dimension of the company’s finances, such as book value, earnings, sales or cash flow. Examining those elements in isolation, though, may provide a limited perspec­tive on the stock’s valuation.

FlexShares believes that value investors should fall back on the principle of diversifi­cation: Just as holding different types of assets helps improve a portfolio’s risk-adjusted returns, analyzing companies across multiple valuation metrics may help better capture the value premium — and reduce the risk of mischaracterizing stocks:

  • A stock that’s considered a value investment based on one metric could look expensive according to others.
  • The efficacy of valuation metrics can change over time. For example, price-to-book ratio historically has offered the best return premium when examining data back to 1927, it but may be less effective in today’s economy, when companies increasingly rely on intangible assets such as intellectual property and goodwill.
  • Some ratios can change quickly — such as price-to-earnings — which could cause unnecessary turnover in a portfolio.

For these reasons, FlexShares uses a composite value score based on price-to-earn­ings, price-to-book, price-to-cash flow and price-to-dividend yield. We believe this mix helps capture a more complete picture of valuation and reduces turnover.


Another important dimension to consider is how a stock’s current valuation com­pares both with its historical levels and where it might be in the future. Current valuations are often based on a company’s most recent financial statements, but cyclical forces can quickly affect the earnings, sales, cash flow and book value of individual companies, sectors or even the entire market.

For example, oil company earnings historically move with macroeconomic forces that affect the price of oil. When oil prices are high, oil stocks may look extremely inexpensive based on current valuations. Looking back over several years and calculating the average valuation for that particular stock, however, may provide a normalized view that may help avoid short-term financial distortions that may not reflect ongoing operations of a business.

Likewise, using future estimates — such as analysts’ earnings projections — may help gauge where the company might be going and whether those expectations are reflected in its current stock price. Taking a long-term view of company valuations in this way can potentially help a fund’s strategy control for cyclicality in markets or sectors when identifying potential stocks to hold in a portfolio.


Whatever signals a value strategy uses, how that portfolio obtains its value exposure may affect its risk and return profile.

One important consideration is that we believe the value factor’s full cycle is quite long compared with other factors like low volatility and momentum. As a result, value may experience long periods of underperformance. One way to manage that cyclicality is to combine value with other factors. For example:

  • A strategy that combines value with quality — which are both powerful on their own — may provide smoother overall performance over long periods by avoiding low-quality value stocks that could reduce the portfolio’s returns or increase its volatility.

Other portfolio-construction techniques may help reduce the risk that a value strategy is overly concentrated in specific stocks or sectors:

  • Strategies that look for value stocks in every sector may help avoid overweights to traditional value sectors and provide better exposure to the value factor across the broader market. Likewise, holding a larger number of stocks may help reduce the idiosyncratic risk that may arise from concentrated value portfolios that only hold 30–50 stocks.

When combined with a diversified approach to measuring value, thoughtful portfolio-construction techniques like these may help strategies target their value exposure in a way that may help to capture the long-term return potential of the value premium.

For more on FlexShares' approach to value investing, see our Fund pages:

FlexShares Morningstar® U.S. Market Factor Tilt Index Fund (TILT)

FlexShares US Quality Large Cap Index Fund (QLC)


The FlexShares approach to investing is, first and foremost, investor-centric and goal oriented. We pride ourselves on our commitment to developing products that are designed to meet real-world objectives for both institutional and individual investors. If you would like to discuss the attributes of any of the ETFs discussed in this report in greater depth or find out more about the index methodology behind them please don't hesitate to call us at 1-855-FlexETF (1-855-353-9383).