Value vs. Growth & Taxes

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MNS CA
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Value vs. Growth & Taxes

Post by MNS CA » Mon Jul 30, 2018 6:27 pm

I've heard that historically value stocks outperform growth stocks (Fama & French).

Here's a question--could this be explained by the higher tax cost of holding value stocks? Value stocks tend to pay dividends, thus there is an annual personal tax bill. Growth stocks tend not to pay dividends (or to pay fewer), thus there is a lower tax cost ratio and more tax deferral.

If most investible assets are in taxable accounts, could it be that those folks chase growth stocks to keep tax costs low, which bids up growth stocks and makes them a poorer investment?

While value stocks only make sense to hold in tax free or tax deferred accounts (because of annual taxation of dividends), so they stay cheaper.

Does this sound plausible?

jalbert
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Re: Value vs. Growth & Taxes

Post by jalbert » Mon Jul 30, 2018 6:45 pm

Not particularly plausible. The Vanguard value index fund admiral shares only pays about 70 bp/yr more in dividends than the total market index fund admiral shares. The tax drag is then in the range of 7-10 bp/year, which would not be a statistically significant excess return in a backtest of value stocks if that were the finding.
Last edited by jalbert on Mon Jul 30, 2018 6:46 pm, edited 1 time in total.
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Grt2bOutdoors
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Re: Value vs. Growth & Taxes

Post by Grt2bOutdoors » Mon Jul 30, 2018 6:46 pm

No. People chase growth stocks because of human nature; they are pigs and greedy! :greedy :moneybag :greedy
Rationale people do not overpay for hopes and dreams; irrational people will pay any price for the hope they will hit it big. Examples of irrational people are those who will buy hundreds of lottery tickets, even though common sense says the odds of any 1 ticket winning is 1 in 259,000,000. Irrational people think buying more tickets equals having more chances of winning, when the odds of each ticket winning remains the same: 1 in 259,000,000. Example, those who bought FaceBook at $210 last week just before the earnings announcement, only to get taken to the woodshed as the stock plummeted down to $175 as earnings failed to meet expectations. Today, the stock closed at $171 and change, last I saw.

Value purchasers believe in paying less than fair value for assets, since the price is already depressed because the market expects dismal performance. Any performance that exceeds expectations will lead to rational purchasers recognizing the value and bidding up the price, leading to significant capital appreciation. The dividends for those companies which are financially strong but depressed are used to encourage shareholders to stay for the turnaround, but a company does not need to offer a dividend to be a value buy. Companies that sell for significant discounts but don't offer a cash dividend are still value plays. Who doesn't like purchasing $1's worth of assets for 50 cents or 60 cents?
"One should invest based on their need, ability and willingness to take risk - Larry Swedroe" Asking Portfolio Questions

jalbert
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Re: Value vs. Growth & Taxes

Post by jalbert » Mon Jul 30, 2018 6:48 pm

It is not clear that very many individual investors have much influence on market prices.
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Dottie57
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Re: Value vs. Growth & Taxes

Post by Dottie57 » Mon Jul 30, 2018 6:50 pm

How is a stock determined to be a value stock?

jalbert
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Re: Value vs. Growth & Taxes

Post by jalbert » Mon Jul 30, 2018 7:18 pm

In the original work of Fama & French published in 1992, the price-to-book multiplier was used, but inverted as book-to-market price ratio.
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MNS CA
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Re: Value vs. Growth & Taxes

Post by MNS CA » Tue Jul 31, 2018 2:45 pm

jalbert wrote:
Mon Jul 30, 2018 6:45 pm
Not particularly plausible. The Vanguard value index fund admiral shares only pays about 70 bp/yr more in dividends than the total market index fund admiral shares. The tax drag is then in the range of 7-10 bp/year, which would not be a statistically significant excess return in a backtest of value stocks if that were the finding.
According to Morningstar VTV (Vanguard Value) has a tax cost ratio of 0.61 (61 bps) and VUG (Vanguard Growth) has a tax cost ratio of .33 (33 bps). Total market (VTI) is .47 (47 bps).

So its about a 14 bps savings by putting growth in taxable and value in tax-free/tax deferred. Expense ratios and trading costs presumably eat some of that up, though at least at first. So maybe .10 (10bps difference) is a reasonable estimate.

MNS CA
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Re: Value vs. Growth & Taxes

Post by MNS CA » Tue Jul 31, 2018 2:50 pm

Grt2bOutdoors wrote:
Mon Jul 30, 2018 6:46 pm
No. People chase growth stocks because of human nature; they are pigs and greedy! . . .
Value purchasers believe in paying less than fair value for assets, since the price is already depressed because the market expects dismal performance.
Do people still believe in the value premium? I.e., do they still believe that value stocks will outperform growth stocks over the long run? Since 2008 or 2004, Growth stocks have outperformed (https://finance.yahoo.com/chart/VTV#eyJ ... 1pbiI6MX0=compare VUG to VTV).

MotoTrojan
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Re: Value vs. Growth & Taxes

Post by MotoTrojan » Tue Jul 31, 2018 2:55 pm

While I don’t agree with the OP thought, it is flawed analysis to say the value premium is greater than the difference in tax cost. Any amount of perceived benefit to growth stocks could explain a much larger bias of investor influx. They aren’t coupled at all.

Grt2bOutdoors
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Re: Value vs. Growth & Taxes

Post by Grt2bOutdoors » Tue Jul 31, 2018 3:34 pm

MNS CA wrote:
Tue Jul 31, 2018 2:50 pm
Grt2bOutdoors wrote:
Mon Jul 30, 2018 6:46 pm
No. People chase growth stocks because of human nature; they are pigs and greedy! . . .
Value purchasers believe in paying less than fair value for assets, since the price is already depressed because the market expects dismal performance.
Do people still believe in the value premium? I.e., do they still believe that value stocks will outperform growth stocks over the long run? Since 2008 or 2004, Growth stocks have outperformed (https://finance.yahoo.com/chart/VTV#eyJ ... 1pbiI6MX0=compare VUG to VTV).
That’s not a long enough chart.
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triceratop
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Re: Value vs. Growth & Taxes

Post by triceratop » Tue Jul 31, 2018 3:38 pm

For me, small value is more tax efficient than total market.

It's not a crazy idea altogether, though. There have been studies where some outperformance is attributed to tax differences, in treasuries versus corporate bonds.
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jalbert
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Re: Value vs. Growth & Taxes

Post by jalbert » Tue Jul 31, 2018 4:57 pm

According to Morningstar VTV (Vanguard Value) has a tax cost ratio of 0.61 (61 bps) and VUG (Vanguard Growth) has a tax cost ratio of .33 (33 bps). Total market (VTI) is .47 (47 bps).
I’ve never found the M* tax cost ratios to be very useful.
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Artsdoctor
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Re: Value vs. Growth & Taxes

Post by Artsdoctor » Tue Jul 31, 2018 5:02 pm

MNS CA wrote:
Mon Jul 30, 2018 6:27 pm
I've heard that historically value stocks outperform growth stocks (Fama & French).

Here's a question--could this be explained by the higher tax cost of holding value stocks? Value stocks tend to pay dividends, thus there is an annual personal tax bill. Growth stocks tend not to pay dividends (or to pay fewer), thus there is a lower tax cost ratio and more tax deferral.

If most investible assets are in taxable accounts, could it be that those folks chase growth stocks to keep tax costs low, which bids up growth stocks and makes them a poorer investment?

While value stocks only make sense to hold in tax free or tax deferred accounts (because of annual taxation of dividends), so they stay cheaper.

Does this sound plausible?
Be careful how you interpret the data: "historically, value stocks outperform growth stock" will need to be qualified. Are you talking about after-tax returns or not?

Value stocks will generally throw off more dividends than growth stocks, some will be qualified and some will not. Depending on an investor's marginal tax rate, the after-tax return of value stocks may not be superior. This is often not considered when old adages are reiterated.

MNS CA
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Re: Value vs. Growth & Taxes

Post by MNS CA » Wed Aug 01, 2018 7:28 pm

Artsdoctor wrote:
Tue Jul 31, 2018 5:02 pm

Be careful how you interpret the data: "historically, value stocks outperform growth stock" will need to be qualified. Are you talking about after-tax returns or not?

Value stocks will generally throw off more dividends than growth stocks, some will be qualified and some will not. Depending on an investor's marginal tax rate, the after-tax return of value stocks may not be superior. This is often not considered when old adages are reiterated.
I'm talking about pre-tax returns. Since I can load up on value in a tax-free / tax deferred account and keep growth or the index in taxable.

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vineviz
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Re: Value vs. Growth & Taxes

Post by vineviz » Wed Aug 01, 2018 7:39 pm

MNS CA wrote:
Tue Jul 31, 2018 2:50 pm
Grt2bOutdoors wrote:
Mon Jul 30, 2018 6:46 pm
No. People chase growth stocks because of human nature; they are pigs and greedy! . . .
Value purchasers believe in paying less than fair value for assets, since the price is already depressed because the market expects dismal performance.
Do people still believe in the value premium? I.e., do they still believe that value stocks will outperform growth stocks over the long run? Since 2008 or 2004, Growth stocks have outperformed (https://finance.yahoo.com/chart/VTV#eyJ ... 1pbiI6MX0=compare VUG to VTV).
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garlandwhizzer
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Re: Value vs. Growth & Taxes

Post by garlandwhizzer » Wed Aug 01, 2018 9:22 pm

I don't know when the growth/value tide will turn again and value will once again have its day. Historically the two styles alternate in outperformance over time spans measured in years, not months. I believe there have been periods as long as 15 years historically in which value underperformed. Currently it's about 11 years, and those 11 years started with a market collapse and were followed by a prolonged spell of very low inflation, historically low interest rates, and very sluggish economic growth, conditions in which significant corporate profit growth is difficult for value stocks. Growth stocks on the other hand often have the capacity to grow profits even when the macroeconomy struggles which has been the case for LC tech giants like Apple, Google, and Facebook among others. Some LC tech high flyers like Netflix, Tesla, and Amazon have massively inflated market caps with little or nothing in the way of profits. Hundreds of billions of market cap built on nothing more than a convincing narrative. Such has been the market's appetite for growth while value has struggled.

Recently we're seeing increasing economic growth (4.1% GDP growth Q2) and increasing inflation (CPI 2.9% over the last year), the highest readings in years. Investors are starting to ask whether now is the economy is going to take off in which case we'd might expect value to emerge and outperform. Inflation is more lethal to growth stocks because growth's future profits you're prepaying for now are discounted by inflation. Growth likes very low inflation and that might or might now be changing Like all other serious questions about the market's future we don't know what's going to happen.

The question in my mind is whether the recent trend of increasing growth and inflation are just a sugar high from sudden tax cuts, repatriation of corporate profits from abroad combined with increased government spending? Is our it sustainable long term--moderate inflation and robust economic growth without however overheating the economy which invariably leads to increasing inflation and tighter credit. Trade policy risks, normalization of interest rates, dollar strength which hurts our exports, end of QE backstop, increased inflation from tariffs on imports, refinancing of our massive public debt in an environment of increasing rates, and geopolitical conflict/uncertainty are real risks going forward. These wild cards whose direction, although unknown, likely will have a significant impact on our future and the market's future. These issues must be navigated carefully.

As usual with markets, there's lots of risk to worry about but also reasons for optimism. I believe the disparity between the economy which is strong and growing now and the market which, 7 months later is still below its January highs, reflects these uncertainties. It's odd. In the earlier stages of this long bull market the market boomed while the economy struggled. Now the economy is booming and the market worries in spite of much higher corporate profits from tax cuts. We live in interesting times. It's always a good time for wide portfolio diversification, this one especially.

Garland Whizzer

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