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Value and Growth: When does it Matter?

June 15, 2021

Posted in Decoding

If you have spent any amount of time watching tv, listening to a stock market update on the radio or browsing the financial papers, you have invariably come across references to “growth” or “value” stocks and mutual funds.  Although intuitively you may understand the difference, why does it matter? Let’s take a look.

Growth stocks represent companies with high earnings growth over recent quarters or years and are expected to continue strong revenue and earnings growth going forward. Many of these exceptional companies are now focused on innovative technology, disruptive business models, or both.

Typically, growth stocks are priced higher than the overall market based on fundamental measures like price-to-earnings (P/E) or price-to-cashflow due to elevated earnings expectations.  Often, these companies can achieve high earnings growth regardless of economic conditions (think Amazon). One key risk to growth investing is if elevated earnings do not materialize, the stock price can fall quickly to a less exceptional market multiple.

Value stocks, in contrast, are often priced lower than average based on P/E, price-to-cashflow, or price-to-book measures. Value companies often carry lower prices as they are more mature companies or in industries with lower or more volatile earnings growth. They can also be priced lower due to legal problems or negative publicity raising doubts about the firm’s long term-prospects (think Boeing). While investors may be paying a lower price for a value stock, they often need to be patient as it can take time for a company to turn operations around or for the right economic conditions to materialize.

Value vs. Growth Historically

Historically, value stocks have outperformed growth stocks over longer periods of time. According to Capital Group, global value stocks outperformed their growth peers by 130% from 1974 to the end of 2007:

Values Long-Term Success

However, since the financial crisis in 2007 the opposite has been true; growth stocks steadily outperformed value. This trend accelerated during the COVID-driven downturn as illustrated below.

Growth, Value and the Economic Cycle

Many are wondering if it is time for this trend to reverse once again and according to the economic cycle, it might be.

Value and growth stocks tend to perform relatively better during different periods of an economic cycle. Growth stocks tend to outperform during the middle and late stages of an economic cycle, when economic growth is slowing. Companies that demonstrate higher earnings in this lower growth environment can command higher valuations.

Value stocks often perform best immediately before a recession begins, as many value companies are found in more defensive sectors of the market like utilities and consumer staples. Consumers need to eat and heat homes regardless of economic conditions but may choose to delay upgrading their cell phone until the economy stabilizes.

Value companies in the energy, material, financial and industrial sectors can do well immediately after a recession as economic growth is accelerating. Additionally, these company’s stock prices often fall, sometimes dramatically, during a recession as overall demand is reduced. Investors who accumulate shares at these lower prices often are rewarded as value company earnings recover and are amplified early in the economic cycle when demand improves.

While many indicators show the US economy in the early stages of the economic cycle and global growth improving no one can be entirely certain if value stocks will continue their recent outperformance. Clients of Johnson Bixby are guided to well diversified investment portfolios of value, growth, and international stocks of all sizes. Additionally, rebalancing of portfolios as the economic cycle progresses can help maintain diversity and reduce risk by reallocating from positions that have had a run of exceptional growth to companies that may offer a bit more value.

 

Diversification does not guarantee a profit or protection from losses in a declining market.

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