Growth investing vs. value investing: Which is better in today’s market?

This post was originally published on this site

It’s the perennial question among stock investors: which is better – growth investing or value investing? Recently, there’s been little contest. Growth stocks, such as Amazon and Apple, have handily outperformed value names. But it’s not always that way, and many investors think value will once again have its day, though they have been waiting on that day for quite some time.

© Witthaya Prasongsin/Getty Images Someone holds a mobile phone with a stock chart on it

Here’s what investors say about growth and value investing, and when we might see value investing begin to outperform again.

Load Error

Differences between growth investing and value investing

Many see the distinction between growth and value as somewhat arbitrary, but it’s useful to lay out what might differ between the two approaches, even if it seems a bit like a stereotype.

Growth investing

Growth investors look for $100 stocks that could be worth $200 in a few years if the company continues to grow quickly. As such, the success of their investment relies on the expansion of the company and the market continuing to price growth stocks at a premium valuation, as measured by a P/E ratio maybe, in later years if the company continues to succeed.

Growth stocks are sometimes also called momentum stocks, because their strong upward rise leads to more and more investors piling into them. Sometimes that movement occurs regardless of the company’s fundamentals, as investors build “pie in the sky” expectations around the company. When those expectations aren’t realized as quickly as some investors expect, a growth stock can plunge, though it may later rise with renewed optimism.

Value investing

In contrast, value investors look for $50 stocks that are actually worth $100 today, not in a few years, if the company continues its business plan. These investors are typically buying stocks that are out of favor now and therefore have a low valuation. They’re betting on the market’s opinion becoming more favorable, pushing up the stock price.

“Value investing is based on the premise that paying less for a set of future cash flows is associated with a higher expected return,” says Wes Crill, head of investment strategists at Dimensional Fund Advisors in Austin, Texas. “That’s one of the most fundamental tenets of investing.”

Many of America’s most famous investors are value investors, including Warren Buffett, Charlie Munger and Ben Graham, among many others. Still, plenty of very wealthy individuals own growth stocks, including Amazon’s founder Jeff Bezos and hedge fund billionaire Bill Ackman, and even Buffett has shifted his approach to become more growth-oriented these days.

Growth investing and value investing differ in other key ways, too, as detailed in the table below.

Trait Growth investing Value investing
Company features Growing quickly, hot new product, tech stocks Growing slowly or not at all, older products
Valuation (P/E ratio) Higher Lower
Stock popularity In favor, “momentum” stocks Out of favor, “cigar butts”
Dividends Less often More often
Stereotypical stock Amazon, Apple, Facebook Procter & Gamble, Exxon Mobil, Johnson & Johnson
Volatility Higher Lower

But the difference between growth and value investors can sometimes be artificial, as many investors agree. Regardless of their style, investors are trying to buy a stock that’s worth more in the future than it is today. And both value companies and growth companies tend to expand at least a little over time and often significantly. So the definitions of the terms are a bit slippery.

Typical investing wisdom might say that “when the markets are greedy, growth investors win and when they are fearful, value investors win,” says Blair Silverberg, CEO of Hum Capital, a funding company for early-stage firms based in New York City.

“The 2020s are a little different,” Silverberg says. “There are real tailwinds to technology companies and you can actually find value by buying great companies at fair prices.”

And sometimes the difference between the two investing styles may be largely psychological.

The market sometimes overlooks the “earnings growth potential in a company just because it has been bucketed as a value stock,” says Nathan Rex, chief investment officer at Eigenvector Capital in Stamford, Connecticut.

Which is better: growth investing or value investing?

The question of which investing style is better depends on many factors, since each style can perform better in different economic climates. Growth stocks may do better when interest rates are low and expected to stay low, but many investors shift to value stocks as rates rise. Growth stocks have had a stronger run recently, but value stocks have a good long-term record.

Growth stocks continue to outperform

Currently growth stocks have been having a nice go, with the last decade spent running up on the backs of large tech companies with massive opportunities. Tech stocks such as Facebook, Alphabet, Amazon, Apple and Netflix – once named FAANG stocks (when Alphabet used to be called Google) – now dominate the market and comprise a huge portion of key indexes such as the Standard & Poor’s 500. As another trillion-dollar player, Microsoft is also added to this mix.

“In the five years ending 2019, large-cap growth outperformed large-cap value by a cumulative 30 percent,” says Ryan Johnson, CFA, director of portfolio management and research at Buckingham Advisors in Dayton, Ohio. “Still, the annualized return of value was respectable, at over 9 percent.”

So what’s driving growth stocks?

“Investors have become so fearful of short-term events and a low-growth economy that they are willing to pay a higher premium for growth in future years,” says Rex.

The FAANG stocks, for example, all traded over 24 times earnings in late 2021. In contrast, the S&P 500’s historical P/E ratio is closer to 16 times earnings.

“The driver for growth vs. value over the last decade has been the market’s grasp for anything that could demonstrate the ability to increase earnings in a low-growth, disinflationary environment,” says Jeff Weniger, head of equity strategy at WisdomTree Investments in Chicago.

Weniger points to tech and communications services stocks as winners on the growth side, while gesturing to energy and financials as stocks that struggle in this environment, “two sectors that tend to populate value indexes.” The pandemic exacerbated the disparity, as tech stocks may have thrived while old-line companies were hit harder, he says.

“The interest rate environment has been terrible for traditional banks,” says Norm Conley, CEO and CIO at JAG Capital Management in the St. Louis area. While financials are cheap on some measures, “their earnings power has been crimped severely by a flatter, lower yield curve, and the regulatory environment for banks has been anything but supportive since the Great Financial Crisis.”

Conley notes that many value indices are “heavily-weighted to ‘old economy,’ asset-intensive companies, during a period of massive technological growth and disruption.”

Value investing tends to outperform over the long term

While growth stocks might win the short-term battle, value stocks are winning the long-term war, suggests Dr. Robert Johnson, finance professor at Creighton University and co-author of the book “Strategic Value Investing.”

“From 1927 through 2019, according to the data compiled by Nobel Prize laureate Eugene Fama and Dartmouth professor Kenneth French, over rolling 15-year time periods, value stocks have outperformed growth stocks 93 percent of the time,” he says.

But over a shorter period, value may outperform at a lower percentage. Johnson cites the same research showing that in annual periods value outperformed just 62 percent of the time.

But that’s not to say that value stocks as a whole will be winners when the market turns. It’s important to distinguish value stocks that have permanent problems with those that may be suffering temporary setbacks or those the market has soured on for the time being.

“Value investors have always run the risk of plowing capital into stocks that are cheap for a reason and ultimately continue to underperform,” says Conley.

Such stocks are called value traps, but the same phenomenon exists with growth stocks, and investors who buy into highly valued growth names may get burned, if the companies are unable to maintain the rapid expansion that Wall Street demands.

“Both value and growth investors run the risk of investing capital at prices that, in the fullness of time, will prove to have been too high,” says Conley.

When will value outperform growth again?

The question that has been on the minds of many investors is when value stocks will outshine growth stocks. The short answer is, no one knows. The long answer is also, no one knows. But they do know eventually the market will again favor value stocks. Experts point to a few factors to consider when thinking about how value again becomes the more favored approach.

One sign to watch out for: inflation. Weniger says that inflation helps value stocks more than it does growth stocks. The Federal Reserve is doing a lot to stoke inflation where it can.

Some traditional value sectors have performed well of late, as rising energy prices stoked inflation and increased investors’ expectations for higher interest rates. Those rises boosted energy and financial names in 2021, as investors priced in higher profits at these companies. A recent Bankrate survey showed experts expect the yield on the 10-year Treasury to rise an average of 50 basis points, to 1.86 percent, by the end of the third quarter 2022.

“A favorable change in the near-term outlook would remove a great deal of the fear and pessimism that are currently holding value stocks back,” says Rex. With such a change “value stocks which are growing earnings more quickly than growth stocks will begin to outperform.”

And value stocks are exactly where financial experts questioned in Bankrate’s third-quarter survey expect to see outperformance through September 2022.

“When, not if, U.S. large-cap tech falls out of favor, value’s relative performance will improve,” says Johnson of Buckingham Advisors.

Many investors point to long-term studies showing that eventually the market does re-rate value stocks.

“Our research shows that value investing continues to be a reliable way for investors to increase expected returns going forward,” says Crill. He suggests that the longer you stay invested, the more likely value is to outperform, since “history tells us value can show up in bunches.”

And a plain old “correction” in stocks or a bear market may return value stocks to favor. With lower expectations built into their prices, value stocks often don’t suffer the kind of downturn that higher-valued stocks do when the market sells off.

“Bull market leaders are often bear market laggards, so it could be that the market hitting a rough patch is what causes beleaguered value stocks to outperform, much as they did from 2000 to 2002, when that era’s go-go stocks came back to earth,” says Weniger.

“Eventually – and I don’t know whether this means next month, next year, or 10 years from now – investors will recognize the attractiveness of [solid value stocks], and value will outperform for some meaningful period of time,” says Conley.

Bottom line

The old debate of growth vs. value will live on, but the empirical evidence suggests that value stocks outperform over time, even if growth stocks steal the daily headlines. If they’re buying individual stocks, investors should stick to fundamental investing principles or otherwise consider buying a solid index fund that takes a lot of the risk out of stocks.

Learn more:

Continue Reading