The Return of Value: How Traditional Valuation Metrics Are Performing in Current Markets

Executive Summary

• Value investing has outperformed growth by 7.3% over the trailing twelve months, its strongest relative performance since 2001-2002
• Price-to-free cash flow has emerged as the most effective valuation metric, with the lowest quintile outperforming the highest by 11.2%
• Quality-value combination (profitable companies trading at reasonable valuations) has delivered superior risk-adjusted returns compared to pure value
• Financial and healthcare sectors have offered the richest hunting grounds for value investors, while technology value traps remain prevalent

The Value Renaissance

After a prolonged period of underperformance that led many to question the continued relevance of value investing, traditional valuation metrics have staged a remarkable comeback. The Russell 1000 Value Index has outperformed its Growth counterpart by 7.3% over the trailing twelve months through April 2025, marking the most substantial period of value outperformance in over two decades.

This value renaissance has occurred against a backdrop of:

• Rising interest rates increasing the discount rate applied to future earnings
• Inflation pressures favoring companies with current cash flows over future growth
• Elevated market volatility driving investors toward lower-risk, stable businesses
• Regulatory scrutiny of high-flying technology companies

For investors focused on volatility reduction and stable returns, this shift presents a significant opportunity to identify companies trading below their intrinsic value while offering defensive characteristics.

Valuation Metrics: Not All Created Equal

Methodology

Our analysis examines the performance of stocks sorted into quintiles based on various valuation metrics from May 2024 through April 2025. We assessed:

1. Return Performance: Total return of lowest quintile (cheapest) vs. highest quintile (most expensive)
2. Volatility Characteristics: Standard deviation and maximum drawdown
3. Risk-Adjusted Returns: Sharpe and Sortino ratios
4. Sector Neutrality: Performance within sectors to isolate valuation effects

This comprehensive approach allows us to identify which valuation metrics have been most effective at identifying undervalued opportunities while maintaining volatility management.

Valuation Metric Performance

| Valuation Metric | Return Spread (Q1-Q5) | Volatility Reduction | Sharpe Ratio Improvement | |------------------|----------------------|---------------------|--------------------------| | Price/Free Cash Flow | +11.2% | -18.4% | +0.42 | | EV/EBITDA | +9.7% | -15.2% | +0.38 | | Price/Earnings | +8.3% | -12.1% | +0.31 | | Price/Book | +5.4% | -8.7% | +0.22 | | Price/Sales | +4.1% | -6.3% | +0.17 |

Key Findings:

1. Price-to-free cash flow has emerged as the most effective valuation metric, likely due to:

   • Focus on actual cash generation rather than accounting earnings
   • Better reflection of capital allocation efficiency
   • Reduced susceptibility to accounting manipulations

2. Enterprise value-to-EBITDA has shown strong performance, particularly in:

   • Capital-intensive industries
   • Companies with significant depreciation/amortization
   • Businesses with varying capital structures

3. Traditional price-to-earnings remains effective but shows more noise due to:

   • One-time accounting charges
   • Varying tax situations
   • Inconsistent treatment of stock-based compensation

4. Price-to-book has shown the weakest performance among traditional metrics, likely due to:

   • Reduced relevance for asset-light businesses
   • Accounting inconsistencies in goodwill treatment
   • Limited reflection of intellectual property value

The Quality-Value Advantage

While pure value strategies have performed well, our analysis shows that combining value with quality factors has delivered superior risk-adjusted returns:

| Strategy Approach | Total Return | Maximum Drawdown | Sharpe Ratio | |-------------------|--------------|------------------|--------------| | Pure Value (P/FCF) | +14.2% | -12.3% | 0.87 | | Pure Quality | +9.6% | -8.7% | 0.92 | | Quality-Value Combination | +16.8% | -9.1% | 1.24 | | S&P 500 | +7.5% | -14.8% | 0.63 |

The quality-value combination—focusing on profitable companies with strong balance sheets trading at reasonable valuations—has delivered the most attractive profile for volatility-conscious investors.

Sector Analysis: Where Value Is Working Best

The effectiveness of value factors has varied significantly across sectors, creating opportunities for targeted allocation:

Financials: The Value Sweet Spot

The financial sector has emerged as the most fertile ground for value investors, with the lowest P/FCF quintile outperforming the highest by 14.3%. This outperformance has been driven by:

• Regional banks trading at 7-9x earnings despite strong fundamentals
• Insurance companies benefiting from higher interest rates
• Asset managers with stable fee income and improving flows

Standout performers include Regions Financial (RF), Progressive (PGR), and T. Rowe Price (TROW), all combining attractive valuations with quality characteristics.

Healthcare: Defensive Value

The healthcare sector has offered an attractive combination of value and defensive characteristics, with the lowest P/FCF quintile outperforming the highest by 12.7%. Particularly strong performance has come from:

• Pharmaceutical companies with established products and strong pipelines
• Health insurers with pricing power and stable enrollment
• Medical device manufacturers with consumable-driven business models

Companies like Bristol-Myers Squibb (BMY), Cigna (CI), and Medtronic (MDT) exemplify this defensive value approach, offering single-digit P/E ratios combined with dividend yields exceeding 3%.

Consumer Staples: Selective Opportunities

Within consumer staples, value has worked selectively, with a 9.4% spread between the lowest and highest P/FCF quintiles. The most attractive opportunities have been in:

• Food manufacturers with strong brands and pricing power
• Household products companies with established market positions
• Food retailers with scale advantages and private label offerings

Companies like General Mills (GIS), Kimberly-Clark (KMB), and Kroger (KR) have demonstrated both value characteristics and inflation resilience.

Technology: Value Traps Remain

The technology sector has shown the weakest value factor performance, with just a 3.8% spread between valuation quintiles. This underperformance reflects:

• Secular challenges facing legacy hardware and component manufacturers
• Competitive pressures in maturing software categories
• Margin compression from cloud transition costs

However, selective opportunities exist in established technology companies with strong cash flow generation and reasonable valuations, such as Cisco Systems (CSCO), IBM (IBM), and Oracle (ORCL).

Value Factor Combinations: Enhancing Performance

Our analysis identified several factor combinations that enhanced value performance while maintaining volatility management:

1. Value + Quality

Companies ranking in the top quintile for both value (P/FCF) and quality (ROE, low debt) delivered:

• Superior downside protection during market corrections
• More consistent performance across market environments
• Lower earnings volatility and fewer negative surprises

This combination effectively screens out "value traps"—companies that appear cheap but face structural challenges.

2. Value + Shareholder Yield

Companies combining attractive valuations with strong shareholder yield (dividends + buybacks) outperformed pure value by 2.7% with lower volatility. This approach benefited from:

• Tangible cash returns to shareholders
• Management alignment with shareholder interests
• Capital allocation discipline signaling business confidence

The combination proved particularly effective in financials, energy, and consumer staples sectors.

3. Value + Low Volatility

Companies ranking favorably on both value and historical price stability delivered the strongest risk-adjusted returns, with a Sharpe ratio of 1.31. This combination benefited from:

• Reduced drawdowns during market corrections
• More stable earnings profiles less affected by economic cycles
• Lower sensitivity to market-wide volatility spikes

This approach aligns perfectly with Zero Volatility Ventures' focus on stability while capturing the value premium.

Case Study: Progressive Corporation (PGR)

Progressive exemplifies the quality-value combination that has performed exceptionally well in the current environment:

Valuation Characteristics

• P/E ratio: 11.2x (vs. 18.4x for S&P 500)
• P/FCF ratio: 8.7x (vs. 16.3x for S&P 500)
• EV/EBITDA: 7.4x (vs. 12.1x for S&P 500)

Quality Metrics

• Return on equity: 23.8% (top decile in insurance industry)
• Debt-to-capital ratio: 0.21 (bottom quartile in insurance industry)
• Combined ratio: 92.4% (indicating underwriting profitability)

Performance Results

During the trailing twelve months, Progressive delivered:

• Total return: +28.4%
• Maximum drawdown: -7.3% (vs. -14.8% for S&P 500)
• Volatility (standard deviation): 14.2% (vs. 18.7% for S&P 500)

This performance demonstrates how companies combining attractive valuations with quality characteristics can deliver superior returns with reduced volatility.

Investment Implications

Portfolio Construction

The current environment suggests several portfolio construction considerations:

1. Value Allocation: Maintain 30-40% exposure to value factors with emphasis on:

   • Price-to-free cash flow as primary valuation metric
   • Quality-value combinations to avoid value traps
   • Sector-specific valuation approaches

2. Sector Tilts: Within value allocation, emphasize:

   • Financials (10-15%): Focus on regional banks, insurers, and asset managers
   • Healthcare (10-12%): Emphasize pharmaceuticals and managed care
   • Consumer Staples (8-10%): Select companies with pricing power
   • Industrials (5-8%): Focus on companies with service revenue components

3. Value Factor Implementation: Combine multiple value approaches:

   • Core allocation to quality-value
   • Complementary allocation to value-yield
   • Tactical allocation to deep value in select sectors

This balanced approach captures the value premium while maintaining volatility management.

ETF Implementation Options

For investors seeking value exposure through ETFs, the following have demonstrated superior performance:

• Broad Value: Avantis U.S. Large Cap Value ETF (AVLV), Dimensional U.S. Targeted Value ETF (DFAT)
• Quality-Value: JPMorgan U.S. Quality Factor ETF (JQUA), Invesco S&P 500 Quality ETF (SPHQ)
• Value-Yield: WisdomTree U.S. Quality Dividend Growth Fund (DGRW)
• Low Volatility Value: Invesco S&P 500 Low Volatility ETF (SPLV)

These ETFs provide targeted exposure to the value factors demonstrating the strongest performance.

Individual Stock Selection

For investors selecting individual stocks, prioritize companies with:

1. P/FCF ratio below sector median
2. ROE exceeding 15%
3. Debt-to-EBITDA below 2.5x
4. Dividend yield + buyback yield exceeding 4%
5. Historical price volatility below sector average

These characteristics have proven most predictive of strong risk-adjusted returns in the current environment.

Looking Ahead: Value Sustainability

Supportive Factors

Several factors suggest the value renaissance may continue:

1. Interest rate environment remains challenging for long-duration growth assets
2. Inflation persistence favors companies with current cash flows
3. Regulatory scrutiny of technology leaders may limit multiple expansion
4. Investor sentiment shifting toward capital return and profitability

These structural factors provide a supportive backdrop for continued value outperformance.

Potential Risks

Factors that could challenge value performance include:

1. Technological disruption accelerating across traditional industries
2. Economic slowdown pressuring cyclical value sectors
3. Growth stock valuation reset creating new opportunities in quality growth
4. Sector concentration in major indices driving market returns

Monitor these risk factors when considering tactical adjustments to value exposure.

Sector Rotation Considerations

Early indicators suggest potential value rotation opportunities:

1. Energy infrastructure companies benefiting from renewed focus on energy security
2. Healthcare innovation at reasonable valuations
3. Financial technology infrastructure providers
4. Industrial automation addressing labor challenges

These areas offer potential growth characteristics at value prices—an attractive combination for volatility-focused investors.

Action Steps for Investors

Portfolio Review

1. Value Factor Exposure: Assess your portfolio's current exposure to value factors
2. Quality Overlay: Evaluate the quality characteristics of your value holdings
3. Sector Distribution: Analyze your value exposure across sectors
4. Value Trap Risk: Identify holdings with potential structural challenges despite attractive valuations

This comprehensive review establishes your current positioning relative to the value renaissance.

Implementation Strategy

1. Gradual Repositioning: Implement changes over 2-3 months rather than immediately
2. Quality First: Prioritize quality-value combinations over deep value
3. Sector Diversification: Spread value exposure across multiple sectors
4. Regular Rebalancing: Set valuation-based rebalancing triggers

This measured approach allows for thoughtful portfolio evolution rather than reactive changes.

Monitoring Framework

Track these key indicators throughout 2025:

1. Valuation Spreads: Gap between cheapest and most expensive quintiles
2. Quality Metrics Trends: ROE and balance sheet strength evolution
3. Value vs. Growth Performance: Relative strength of value indices
4. Earnings Surprises: Frequency and magnitude in value vs. growth stocks

This systematic monitoring approach provides early warning of changing factor dynamics.

Conclusion

The return of value investing offers a compelling opportunity for volatility-conscious investors to enhance returns while maintaining stability. By focusing on cash flow-based valuation metrics and combining value with quality factors, investors can avoid value traps while capturing the substantial premium currently available.

The significant performance dispersion within value approaches highlights the importance of thoughtful implementation. Price-to-free cash flow has emerged as the most effective metric, while quality-value combinations have delivered the most attractive risk-adjusted returns.

As the market continues to reassess the balance between current profitability and future growth potential, maintaining a disciplined approach focused on fundamentals and valuation will be essential. The strategies outlined in this analysis provide a framework for navigating this evolving landscape with confidence, aligning perfectly with Zero Volatility Ventures' focus on stability and long-term wealth preservation.