The Value Factor Explained: Buying Cheap Stocks
Buying cheap stocks has a long academic pedigree and a brutal 2010s. Here's how value is measured, why it has historically paid, and why it tests your patience.
Don't have time? Here's what you need to know:
- 1The value factor buys cheap stocks (low price-to-book, low P/E) and rests on the 1992 Fama-French model showing cheap stocks historically outperformed expensive ones.
- 2Broad large-cap value ETFs like VTV cost about 0.04%; deeper small-cap value tilts like AVUV cost more and carry more volatility.
- 3Value underperformed the broad market for much of the 2010s before rebounding in 2021–2022 — the premium is real long term but can disappoint for a decade.
- 4Value works only if you can hold it through long droughts; selling after a bad stretch is the most common way investors destroy the premium.
What 'Value' Means in a Factor
The value factor is the tendency for cheap stocks to outperform expensive ones over long periods. 'Cheap' is measured by valuation ratios — most classically book-to-market (the academic version), but in practice also price-to-earnings, price-to-cash-flow, and price-to-sales. A value ETF screens the market for stocks trading at low multiples and weights toward them, rather than holding every company in proportion to its size.
This is a different idea from buying a 'good company.' A value stock is often a mature, unglamorous, or temporarily troubled business — a bank, an energy producer, an old-line industrial — that the market has priced pessimistically. The bet is not that the business will become exciting, but that the pessimism is overdone and the low price more than compensates for the risk.
The Fama-French Evidence
Value's academic foundation is the 1992 Fama-French three-factor model, which added size and value (book-to-market) to market beta and found they explained the cross-section of stock returns far better than beta alone. Across long historical samples and many countries, portfolios of cheap stocks earned more than portfolios of expensive ones — the 'value premium.'
Why? The risk story says cheap stocks are riskier: they are concentrated in distressed firms that perform terribly in recessions, so the premium is compensation for that pain. The behavioral story says investors overpay for exciting growth names and underprice boring cheap ones. Both can be partly true, and both imply the premium only survives because holding value is genuinely uncomfortable at times.
How the Major Value ETFs Differ
Most large-cap value ETFs use a similar idea but different index rules, which is why their holdings and tilts vary. The table compares three widely held options. VTV is the cheapest and broadest; it tracks a large-cap value index covering hundreds of stocks. IWD follows the Russell 1000 Value. SPYV isolates the value half of the S&P 500.
For a deeper or 'pure' value tilt, some investors look to small-cap value funds such as AVUV, which combine the value and size factors and screen more aggressively for profitability — but these carry higher fees and more volatility than a broad large-cap value fund.
| VTV | IWD | SPYV | |
|---|---|---|---|
| Issuer | Vanguard | iShares | SPDR |
| Index | CRSP US Large Value | Russell 1000 Value | S&P 500 Value |
| Expense ratio | ~0.04% | ~0.19% | ~0.04% |
| Tilt | Broad large-cap value | Broad large-cap value | S&P 500 value half |
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Value's Lost Decade — and Why It Matters
Here is the part the brochures gloss over: value can underperform the broad market for an extraordinarily long time. Through much of the 2010s, U.S. value trailed growth badly as a handful of mega-cap technology companies powered the index higher. The gap grew so wide and lasted so long that many investors and even some commentators declared the value premium dead near what later looked like its low.
Value did rebound sharply in 2021–2022 when rising rates punished expensive growth stocks, which is exactly the lesson: the premium tends to reappear when you have stopped believing in it. But a tilt that can lag for ten-plus years is not for everyone. If you cannot imagine holding value through a decade of underperformance without selling, a plain total-market fund is the more honest choice.
Important: Value's long droughts are a feature, not a bug. The premium exists partly because most investors give up before it pays — which means timing your entry and exit by recent performance usually backfires.
Frequently Asked Questions
How is a value stock actually identified?
By valuation ratios. Index providers screen for low price-to-book (the classic academic measure), and often low price-to-earnings, price-to-cash-flow, or price-to-sales. A value ETF then weights toward the cheapest slice of the market. The exact rules differ by index, which is why VTV, IWD, and SPYV hold somewhat different stocks.
Is the value premium dead?
It is not dead, but it is far less reliable than mid-20th-century backtests implied. U.S. value lagged growth for much of the 2010s before rebounding in 2021–2022. The realistic view is that value has historically added a modest premium over multi-decade periods while being capable of underperforming for a decade at a stretch.
What is the difference between value investing and a value factor ETF?
Classic value investing, in the Buffett or Graham tradition, means analyzing individual businesses to find ones trading below their worth. A value factor ETF mechanizes the cheap part: it screens the whole market by valuation ratios and holds the cheapest stocks by rule, with no judgment about individual companies. It is cheaper and more diversified, but blunter.
Should I combine value with other factors?
Many investors do, because value and momentum in particular have historically been lowly correlated — when value lags, momentum often holds up, and vice versa. Combining them in a multi-factor fund can smooth the ride. The trade-off is that a blended fund waters down any single factor's potential payoff.
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Alex Harrington
CFA Level II Candidate, Finance & Economics
Alex Harrington is an independent ETF researcher and personal finance writer with over 8 years of experience analyzing exchange-traded funds. A CFA Level II candidate with a background in economics, Alex has reviewed 800+ ETFs and helped thousands of beginners build their first investment portfolios through clear, jargon-free education.
This content is for educational purposes only and does not constitute financial advice. Past performance does not guarantee future results. Consult a licensed financial advisor before making investment decisions.