Value Vs. Growth Stocks -- Which Will Come Out on Top?
Investors have shunned bargain-priced stocks in favor of fast growers for years. Is value due for a comeback?
Legends of investing, including Benjamin Graham and his disciple Warren Buffett, have long touted the advantages of value investing. Value stocks trade inexpensively compared with corporate measures such as sales, earnings and book value (assets minus liabilities). Historically, they have outperformed growth stocks, which boost earnings and sales faster than their peers. The thinking behind the value strategy is simple: Investors tend to bid up exciting, fast-growing companies to bloated levels and shun boring companies or those going through temporary problems.
When the market eventually comes to its senses and stock prices normalize, value wins. From July 1926 through May 2018, value stocks traded on U.S. stock markets outpaced growth stocks by an annualized 3.9 percentage points.
But for more than a decade, growth stocks have pummeled their bargain-priced counterparts. Since the beginning of the last bear market in 2007, Standard & Poor’s 500 Value index, which tracks value-oriented components of the broad market barometer, has returned a cumulative 77%, compared with a 179% return in the corresponding growth-stock yardstick. The walloping hasn’t been consistent; value outpaced growth in 2012 and 2016. Led by a still-booming tech sector, growth stocks in the S&P 500 have returned 11.6% so far in 2018, compared with 0.2% for value stocks. (Prices and other data are through July 13.)
Growth stocks usually sparkle in bull markets, but value shares tend to shine in down markets. At least that was the case between 1970 and 2006. When the stock market dropped 55% in the financial crisis and associated bear market of 2007–09, value should have shone. Except that value-oriented financial firms were at the heart of the mess, and lost 82% over the period. From June 2014 to January 2016, energy stocks, also value stalwarts, lost 42% as oil prices plummeted.
At 11 years, value’s current slump is the longest ever—“an extreme outlier,” says Scott Opsal, research director at the Leuthold Group, a market research and money management firm in Minneapolis. So investors are right to ask: Is value investing down for the count? Or is now the time to seize opportunities in a group of stocks poised to get off the mat?
The trends favoring growth have shown few signs of slowing down this year. But today’s environment favors a rebound in value stocks, say many analysts. For starters, whereas stocks of fast-growing companies are most attractive when profits and economic growth are scarce, bargains present better prospects when overall growth accelerates. Today, Wall Street analysts expect corporate profits to rise an average of 22% in 2018, up from 12% last year; Kiplinger estimates 2.9% gross domestic product growth this year, up from 2.3% in 2017.
And although value stocks nearly always look cheaper than growth stocks, the discount today is particularly steep. Despite forecasts of similar levels of earnings gains for growth and value stocks, the S&P 500 Growth index trades at 21 times investment research firm S&P Capital IQ’s estimated 2018 earnings, on average, compared with a price-earnings ratio of 14.5 for the Value index. The 45% premium is well above the post-technology-bubble average of 28%.
Finally, rising short-term interest rates are also thought to benefit value stocks—particularly financial firms, which can reap more on their investments. Although today’s still-low long-term rates offer limited lending profits for the group, continued deregulation is in their favor. With these factors in mind, John Lynch, chief strategist at investment firm LPL Financial, says value is poised for a comeback.
Timing such cycles is difficult. But it’s a good idea to diversify your portfolio with the complementary styles of growth and value. Investors who already do this might find now an opportune time to rebalance. Consider: Someone who started with an equal amount invested in the S&P 500 Growth and Value indexes 10 years ago would now have 58% of assets in growth and 42% in value.
Low-cost ETFs are an inexpensive, easy way to add value stocks to your portfolio. The SPDR S&P 500 Value ETF (symbol SPYV, $30) tracks its namesake index. The fund holds 384 stocks and charges an expense ratio of 0.04%. Top holdings include Berkshire Hathaway, JPMorgan Chase and ExxonMobil. Invesco S&P 500 Pure Value ETF (RPV, $67), with an expense ratio of 0.35%, tracks a limited version of the index featuring only stocks that rank in the bottom third of the S&P 500 by market size and that score high marks for value. Top holdings include CenturyLink and Kohl’s.
For a more targeted approach, consider Kiplinger ETF 20 member Invesco Dynamic Large-Cap Value (PWV, $36). The ETF charges 0.56% of assets and screens holdings for 10 factors, including quality and favorable share-price and earnings trends. The resulting 50-stock portfolio is full of blue chips, such as Procter & Gamble, Coca-Cola and Walt Disney.
Among actively managed funds, consider Dodge & Cox Stock (DODGX), a member of the Kiplinger 25, the list of our favorite no-load funds. The fund’s contrarian managers buy into fundamentally strong businesses whose shares are underpriced because of negative investor sentiment or unfavorable market environments. T. Rowe Price Value (TRVLX) invests in stocks that trade at a discount to historical averages, shares of their peers or the broad market. Both funds sport 15-year returns that place them among the top 13% of large-company value funds over that period.
Comanagers Stephen Yacktman and Jason Subotky at AMG Yacktman Focused Fund (YAFFX) home in on high-quality stocks trading on the cheap, favoring firms with robust free cash flow (cash profits left over after capital outlays) and little exposure to swings in the economy. An insistence on quality has bolstered returns during down markets. The fund, which at last check held only 22 stocks, lost 11.3% in the 2011 stock market correction, compared with an 18.6% decline in the broad market. Top holding: 21st Century Fox, Class B.
Boston Partners All Cap Value (BPAVX) has also proved its mettle during down markets. Manager Duilio Ramallo’s decision to lighten up on financial stocks paid off in 2008. The fund’s 27.6% loss that year beat the S&P 500 by 9.4 percentage points and placed it among the top 4% of large-company value funds. Today, financial stocks are back in the fund’s good graces: JPMorgan Chase, Bank of America and Citigroup are three of the fund’s top four holdings. The fund is also bullish on old-school tech, including Cisco Systems and Oracle.
Successful value investors share a common trait: patience. For those who can wait long enough, the strategy will pay off, says Leuthold’s Opsal. “At some point, the great growth winners of this bull market are going to run out of gas and people are going to get tired of overlooking consumer staples, financials and energy shares. The timing is not something you can put your finger on,” he says, “but there are a lot of ways for value to win.”