If you pay any attention to financial media, you likely heard talk of value overtaking growth as 2020 drew to a close. After numerous years of growth outperformance, the tide appeared to be turning as investor dollars flowed into value names and funds while outflows from growth investments continued to mount in early 2021. But what is this ongoing value-versus-growth investing debate really all about?
The concept of value investing dates back to at least the 1920s, when Benjamin Graham and David Dodd were finance professors at Columbia University. They later penned the classic investment text “Security Analysis”, which revealed the fundamental principles of value investing to the world.
The approach is simple — value investors buy a company’s stock when the price is below its estimated intrinsic or fair value and hold the stock until its market price rises to reflect this valuation. Graham sought out stocks trading at a discount to the company’s net current assets — specifically 66% or more below this threshold.
Value stocks will usually have low price/book (P/B) ratios and low price/earnings (P/E) ratios.
A growth company is expected to increase its profits or revenues faster than the average business in its industry, or even the market as a whole. Companies that are able to do so for extended periods will command higher share prices because investors are willing to pay a premium for potentially outsized returns.
Growth companies reinvest most or all of their profits into growing the business — hence the name. Growth stock prices tend to be more volatile as investors continuously try to determine if the company will deliver the significant growth needed to justify the higher prices paid for these names.
Growth stocks will have higher P/B and P/E ratios or what’s commonly referred to as higher market multiples.
The great debate
Is one actually better than the other though? Not necessarily, and not consistently. Value and growth have different drivers, so their relative performance tends to ebb and flow with changing market and economic factors.
Value will usually outperform during bear markets and economic recessions. Also, value tends to be less volatile than growth, especially during periods of economic or market weakness. A rise in yields might diminish the appeal of growth stocks and push more investors into value investments.
Meanwhile, growth tends to take the lead during bull markets or periods of economic expansion. Also, certain market sectors tend to be more growth-oriented, in particular technology and telecommunications, regardless of prevailing economic or market conditions.
Since their inception in 1979, the Russell 1000 Growth and Value Indexes have nearly identical annual returns through March 2021 — 12.1% for growth versus 12.0% for value. But, the path to those returns was very different.
As the performance gap between growth and value widened in 2020, beyond even what we saw during the 1999 dot-com craze, predictions of value resurging in 2021 started to proliferate. This reignited the age-old debate about the relative merits of value and growth.
Why not both?
Value and growth are complementary, so unless you’re prescient enough to identify the inflection points when one style takes the lead, it probably makes sense to have exposure to both styles in your portfolio.
Some investors believe that value stocks will outrun growth over the long term and exhibit less volatility along the way. Others want that higher-risk, higher-octane growth and are comfortable with the rollercoaster ride if the end result is bigger returns.
Still others will want exposure to both, which should smooth out returns since a portion of their portfolio will benefit from whatever the prevailing market and economic conditions might be.
The single-style portfolio will see more variability in returns as the market moves through different cycles that will favour one style over the other.
Ultimately, there is room for both in portfolios. Some investors will maintain a preference for more of one style or entirely for one style over the other, and that’s their prerogative. Decide on the allocation that makes sense for you and your portfolio, and remember you can always make adjustments.