Value Migration and Valuation Decomposition
Separate business performance from changing valuation spreads before judging value
- Difficulty
- Advanced
- Time to result
- ~months to results
- Steps
- 6
- Confidence
- 93%
This framework decomposes value-factor performance into migration, fundamental growth, and changes in relative valuation. Growth companies that disappoint can fall into the value portfolio after their multiples contract, while value companies that recover can graduate into growth after appreciating. That migration creates a systematic return engine for value, partially offset by the stronger underlying growth and profitability of expensive companies. During a severe value drawdown, investors should determine how much underperformance came from weaker business results and how much came from value becoming still cheaper relative to growth. The distinction matters because expanding valuation spreads may increase prospective returns rather than invalidate the strategy. The analysis should use several valuation measures and adjust accounting book value for intangible assets, which represent a growing share of modern corporate investment.
Origin
Research Affiliates developed this decomposition while investigating claims that value investing had permanently stopped working after its historically severe underperformance relative to growth.
Core principles
- 01Factor returns have multiple underlying engines
- 02Migration between growth and value portfolios matters
- 03Changing valuation spreads can dominate realized returns
- 04Fundamental deterioration and cheaper pricing are different outcomes
- 05Value definitions must account for modern intangible assets
How to run it
- 1
Define the two portfolios
Construct growth and value cohorts using several defensible valuation measures rather than relying exclusively on price-to-book.
Pro tip Compare price-to-earnings, price-to-sales, and fundamentals-to-price measures.
Watch out Different definitions can produce radically different drawdown start dates.
- 2
Track constituent migration
Measure companies moving from growth to value after disappointment and from value to growth after recovery.
Pro tip Attribute returns both before and after each migration event.
Watch out Static portfolio analysis misses a central source of factor returns.
- 3
Measure fundamental contribution
Compare revenue growth, profitability, and other operating results across the two cohorts.
Pro tip Separate business performance from multiple expansion or contraction.
Watch out Better growth-company fundamentals do not automatically justify any valuation spread.
- 4
Measure relative cheapness
Track how the valuation multiple of the value cohort changes relative to the growth cohort.
Pro tip Express the spread consistently across time and valuation definitions.
Watch out A widening spread can make recent value returns look poor even when company fundamentals remain competitive.
- 5
Adjust for intangibles
Capitalize relevant research, intellectual property, processes, and other intangible investment when conventional book value omits them.
Pro tip Use consistent capitalization and amortization rules.
Watch out Unadjusted book value increasingly misclassifies asset-light businesses.
- 6
Interpret the drawdown
Determine whether underperformance reflects damaged fundamentals, slower migration, or a further repricing of value relative to growth.
Pro tip Use the decomposition to form scenarios rather than a single point forecast.
Watch out Extreme historical relationships may not extrapolate cleanly.
In the wild
During a 13-year period, price-to-book value underperformed growth dramatically, but Arnott's team found that much of the shortfall reflected value becoming cheaper relative to growth rather than inferior company performance. Other valuation measures placed the peak much later than price-to-book did.
→ The decomposition suggested that the value mechanism remained active despite headline underperformance.
Research Affiliates tested a price-to-book factor after adjusting book value for intangible assets. Arnott reported that its performance over the studied period was twice as good as the unadjusted version.
→ Accounting adjustment produced a more useful measure of value in an increasingly intangible economy.
Common mistakes
Equating falling price with failing value
A portfolio can underperform because its valuation multiple contracts even when its businesses perform adequately.
Using only price-to-book
Traditional book value misses substantial intangible investment and can distort both classification and historical conclusions.
Extrapolating an extreme rebound mechanically
Historical drawdowns can inform scenarios, but unprecedented spreads do not guarantee proportional future outperformance.
Is it for you?
Best for
It is best for factor investors deciding whether poor value performance reflects deteriorating businesses or expanding valuation spreads.
Not ideal for
It is not ideal for short-horizon market timing or investors using one unadjusted accounting ratio as a complete valuation system.
From the transcript
“One of the core engines for the value factor is migration.”
“if the relative valuation hadn't moved, value would have beak growth again in the last thirteen years”
“price to book is the worst measure for defining value.”
From the episode
Robert Arnott on Global Asset Management (Podcast)
Robert Arnott