Most value investors are painfully aware that the U.S. equity market has not been kind to their preferred investment approach for the past 10 years.
by New York University finance professor Thomas Philippon, I am persuaded that there are structural reasons why big cap growth stocks dominated U.S. equity returns over the past decade. Until this environment changes, small-cap and value stocks may remain on the outside looking in. How can we tell when there has been a switch from beneficial concentration to the defensive version? Prof. Philippon suggests that we look at how corporations allocate their operating surplus funds. In the period 1962-2001, 20 per cent of this cash flow was reinvested in net fixed capital formation – essentially plowed back into the business. From 2002 to 2015, this percentage has dropped to average only 10 per cent of the surplus funds.
With this combination of increasing industry-level concentration, higher after-tax profits and free cash flow directed toward rewarding the owners of the assets, it is no surprise that big cap stocks were the preferred choice of investors over the past 10 years. And, once in place, it is difficult to envisage a scenario that will reverse this momentum.