The chart below divides the year-to-date performance of growth stocks by that of value stocks. When the line rises, growth stocks outperform. When it falls, value stocks outperform. Growth stocks were winning big for most of the year, but this trend reversed sharply last month.
This shift is fueling rampant speculation that the tide has turned for value investors, and greedy growth investors who’ve ignored valuation for too long are getting what they deserve. They dismiss such claims, remaining convinced that growth is the ultimate drug for Wall Street and will be back in vogue soon enough.
The debate between growth and value investing is nothing new, but before picking a side, let’s first discuss the differences between the two investing styles.
Highflyers
Growth stocks represent companies expected to deliver better-than-average revenue and/or earnings. This is where much of the excitement in the stock market can be found because these stocks get the most press, mint millionaires, and award bragging rights at holiday dinners.
For example, Amazon has remained one of the highest-profile growth stocks for over two decades. Investing $10,000 when Amazon went public would be worth over $19 million today1. It’s hard to imagine this type of wealth creation, but it’s easy to understand why so few investors have benefitted from it.
Owning growth stocks requires strong conviction and an even stronger stomach. These stocks tend to be more expensive and exhibit greater volatility. High-flying growth stocks are often priced for perfection, so even the slightest bit of negative news can clip wings.
The chart below shows that even Amazon hasn’t been immune to volatility. It fell over 90% in the early 2000s and took eight years to recover (only to get whacked by over 60% months later). The dotted line also shows that long-term investors have endured regular drawdowns that averaged over 29%. This type of volatility will test the resolve of even the most devout believer.
But the biggest challenge with growth stocks is finding them. Sure, it’s obvious today that Amazon is one of the largest and most successful retailers, but they only sold books in the late 1990s. Furthermore, for every Amazon, there have been countless duds. That’s why picking growth stocks is such a high-risk, high-return business.
It’s Intrinsic
Investors tend to overreact to bad news, so the idea behind value investing is to look for companies with strong fundamentals that have fallen out of favor. Value stocks are also perceived to be less risky since they tend to be priced below the broader market. The thinking is that these stocks have already been hit, so the damage is done.
Although value stocks may not get as much media attention, strategies focusing on slower growth and more mature stocks have their place. For example, value stocks often pay dividends, which have played a significant role in equity returns over the past half century. In fact, approximately 85% of the total return of the S&P 500 Index can be attributed to reinvested dividends and compounding2.
Furthermore, the chart below shows the performance of S&P 500 companies from 1973 through 2023, segmented by dividend payment policy. The two best-performing strategies were those with a focus on dividends.
The allure of value investing is that it’s based on a formulaic process that can be repeated. It’s less abstract and more concrete than the nebulous world of growth investing. Buy a stock whose “intrinsic value” is worth more than what its current price suggests, wait for the market to realize this value, and then ring the register as you get one step closer to becoming the next Warren Buffett.
It sounds too good to be true because it is. To start, calculating a company's “intrinsic value” is borderline impossible and highly subjective. My assessment of the risk of future cash flows for a company could vary greatly from someone else’s.
Furthermore, there are a lot of stocks that are cheap for a reason. These are called “value traps” because they screen cheap but don’t have the fundamentals to rebound over time. Knowing the difference between a value stock and a value trap is a skill that even some of the most successful investors regularly screw up.
Lastly, the fame and fortune of Buffett and other notable value investors have attracted significant competition to the arena. With so many proficient investors running strategies based on the same curriculum taught in every top business school, it’s become harder to find value in the market today than decades ago.
The Bottom Line
In the pantheon of useless financial debates, I’d award “growth vs. value” the silver medal. It’s never made any sense to me why both sides treat this rivalry like Ohio State vs. Michigan. Investing is about risking capital today to achieve future goals. Since there’s more than one goal, both styles have their place.
It’s no different from comparing a minivan to a sports car. If the goal is getting somewhere fast, the sports car is a no-brainer. But if the goal is moving from one apartment to another, that minivan will get the job done faster and with less damage. Debating which is better without first defining the goal makes no sense.
Lastly, for those who think they can profit by trading in and out of factors like these, refer to that first chart again. Take a good hard look at the downward slope of the line last month. These moves tend to happen in a matter of days, and along the way, there are more false alarms than true reversals. If you think you’re good enough to trade these consistently, good luck.
The bottom line is that I’m neither a growth nor a value investor. Instead, I’m a goals-based investor. Tell me your goal, and I’ll do my best to achieve it using the right tools for the job. More often than not, mixing growth and value makes more sense than excluding one.
Sources
1 Bloomberg, as of 7/31/2024
2 https://www.hartfordfunds.com/insights/market-perspectives/equity/the-power-of-dividends.html
Disclosures
This material has been prepared for informational purposes only and should not be construed as a solicitation to effect, or attempt to effect, either transactions in securities or the rendering of personalized investment advice. This material is not intended to provide, and should not be relied on for tax, legal, investment, accounting, or other financial advice. You should consult your own tax, legal, financial, and accounting advisors before engaging in any transaction. Asset allocation and diversification do not guarantee a profit or protect against a loss. All references to potential future developments or outcomes are strictly the views and opinions of Richard W. Paul & Associates and in no way promise, guarantee, or seek to predict with any certainty what may or may not occur in various economies and investment markets. Past performance is not necessarily indicative of future performance.