Is Growth Ready to Outperform Value?
By Jeremy on Nov 06, 2006 with Comments 11
Value stocks have generally been outperforming growth for the past 5 years, but is growth ready for a comeback? When looking at historical trends of growth vs. value it appears that there is a visible cycle that occurs. The image below illustrates this more clearly.
So does this mean you should add more growth to your portfolio? Well, it is impossible to predict when one style will outperform the other, but excluding growth stocks or funds from your investment mix could have an effect on your returns. It may be time to review your investments and see if there is an opportunity to begin to introduce a little more growth into the mix.
Image courtesy of Morningstar
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I’ve never understood the growth vs. value contrast. Presenting them in that light makes it seem as if the terms are mutually exclusive. E.g. is it not possible for a growth stock (however one defines it) to be undervalued? Likewise, is it not possible for a previously undervalued stock to enjoy a great growth run? Guess I’m just looking for what definitions the “industry” uses for value and growth.
And a comment about the graphic: it only goes back to 1970 or so, but I don’t really see a period of time where growth outperforms relative to value when the 36-month rolling (that means annualized, right?) absolute return is negative. With talk of corporate earnings and productivity presently at the historical high end, I have to wonder how much longer 36-month rolling returns can stay positive, let alone above the 10% mark.
Generally speaking the difference between growth and value comes down to this: growth companies are those that growing or expanding rapidly. Value is simply used to describe a company that are trading at a discount based on certain fundamental criteria, meaning they are a good value.
For example in the graphic, look at how growth did throughout the 90′s. As we all know, it was a terrific time for technology and internet stocks. These were growth companies. The start-ups and quickly growing new companies. Then around 2000, the focus shifted to value companies as the bottom fell out of the growth companies. People were looking then for value stocks, avoiding the growth companies.
And given the graphic, it does seem mutually exclusive to an extent, usually growth will perform well when value may not, and vice versa. But, they can both perform fairly well at the same time during a transition period, but investor sentiment will typically tip the scales in one direction or the other.
Thank you for elaborating. I have a few follow-ons:
* I meant to ask for quantification in the value and growth definitions. For a company’s stock could be trading at a very slim discount to value and not be a “good” value stock. Also, how rapidly does a stock have to expand or grow (and over what timeframe) before it makes the cut as a “good” growth stock? I hear “value” and “growth” thrown around a lot but rarely with any numerical clarification. The following question may illuminate my confusion: is Altria a growth stock or a value stock, or both, or neither?
* I wonder if it might be unfair to lump internet stocks with growth stocks in the late 1990s. Everyone remembers “technology”, “internet” and “start-up” from those years, but just as relevant were “speculation” and IPO-as-operating-fund.
* I’m uncomfortable drawing conclusions from a chart covering the last 30-35 years; to do so means that one expects the next 30-35 years to be of a similar nature. But, following along for the moment, I wonder if we have not already missed the boat on this transition. The important point at which one might get the biggest bang from a switch or readjustment would appear to be the point at which growth most deeply underperforms value, i.e. at the blue peaks on the top graphic. Looks like that point most recently was 2002 or so.
* I wonder what Morningstar stays about a pure growth vs. pure value portfolio over the past 35 years. Which outperforms, and by how much? It goes back to your original post where you say “excluding growth or value stocks from your investment mix could have an effect on your returns”. I’d like to learn whether that effect is beneficial or adverse. I.e. why even mess with some undetermined mix of two classes of stock until one learns how each component class performs independently?
I would take a look at this article over at Fool.com, it addresses many of the follow up questions.
Growth vs. Value: Real Distinction or Not?
I think in many cases there can be a lack of distinction between the two simply because fund managers can classify a stock as one or the other differently based on their own valuation criteria. There are no hard and set numbers that automatically classify a stock as value or growth, just generalities.
I’m still looking for a more long-term chart that will display trends over the course of at least 50 years, but have yet to find a good one. In the meantime though, I did find another 25 year comparison that uses a 12-month rolling returns relative to the S&P 500 and it also shows the inverse relationship between growth and value, but stops in 2001.
Growth vs. Value
I will try to dig up more information and hopefully some additional graphics so we can come to more sound conclusions.
Thanks for that fool.com link. That article referenced an earlier fool.com article that speaks to the value v. growth comparison over the long run, using data back to 1927 in that case:
The article references Fama & French as the source of the “value” and “growth” terms. I believe Fama & French use a low P/B ratio as their value definition, but still cannot put my eyes or fingers on the specific cut-off for a low P/B above which a stock is no longer a “value” in their data. I found some discussion about the Efficient Market Hypothesis, and whether or not value stocks offer higher returns *and* lower risk, but I didn’t follow all of it. Seems to be some sort of academic controversy there.
The data for that second graph you posted using value and growth indexes relative to the S&P500 index looks suspiciously symmetrical, almost as if the growth and value indexes are *defined* relative to the S&P 500 index. I wonder if those value and growth indexes are built by decomposing the S&P500 into two halves, one for growth, one for value? Anyway, I’m not convinced indexes are the best way to evaluate value v. growth approaches: index funds are always nearly fully invested (in order to track their index most closely) and that attribute kills the possibility of having any cash available for value bargains, or taking any cash off the table when the growth stocks go orbital.
My HTML skills are close to non-existent. I’ll try that link again:
?
one more try, I apologize for the noise:
http://www.fool.com/news/commentary/2006/commentary06011216.htm
It certainly is a heavily debated issue I’ve realized in all of the searching for additional information. It really comes down to what you want to consider a value stock and a growth stock, and unfortunately most of the data or commentary I’ve come across are very vague or do not specify how they created their classifications, or like you said, just using an index.
That being said, I think generally speaking, growth and value as a whole do have some sort of inverse relationship as shown by various articles and charts, but the real confusion is more or less what classifies a stock or fund as one or the other, and more importantly, how true are the managers of funds staying to their investment objective?
Taking a look at Morningstar, I pulled up the large-cap growth and large-cap value styles and here is what I found:
Morningstar Large-cap Growth – Avg. YTD return: 4.42%
Morningstar Large-cap value – Avg. YTD return: 13.91%
It is no surprise value has been outperforming, and I know this doesn’t answer the historical question on how this trend holds up, but I did find something quite interesting when scanning through each list.
The list of value funds, probably 95% of all funds had double digit YTD returns, most falling right around the average number. Only a handful fell in single digits, most close to 9%. I only saw one fund negative.
On the other hand, looking at the growth list, the YTD returns are terribly inconsistent, with returns ranging from -6.5% upwards of 17%.
Why the discrepancy? How can the value fund managers produce relatively consistent returns among their peers, yet growth managers are all across the board. Are the better performing growth funds introducing some value into their portfolio to get a piece of that action?
I don’t know the answers, I’m just pointing out some observations, but I find it very interesting.
Ok, I did a little more research and I randomly pulled a large-cap growth fund and a large-cap value fund each with returns near the value fund average to see if any of the companies they own overlapped. Not surprisingly, they had quite a few.
The two funds are:
Dreyfus Founders Equity Growth A – FRMAX
AllianceBernstein Value A – ABVAX
A large portion of the holdings overlap, here are the companies that are in both funds:
ExxonMobil
Pfizer
General Electric
JPMorgan Chase
Procter & Gamble
American International Group
Altria Group
HP
Safeway
Colgate-Palmolive
That equals roughly 20% of the growth fund’s assets that overlap with the value fund. Interesting.
Well, good timing, see the new post that may answer some of our questions.
Is Growth Ready to Outperform Value – Follow up