Value vs. Growth Stocks
There are two major approaches to stock investing, value and growth. In an over-generalized sense, value stocks are unloved, boring, and cheap, while growth stocks are expensive, high-flying, and popular.
I talk more about value investing and the subtleties of these definitions on our website here.
The purpose of this blog post is to show value vs. growth investment strategies.
In a nutshell:
- Value investing is akin to buying low and selling high, while growth investing embodies buying high and hoping to sell it higher, which equates to a momentum strategy.
- Value investors calculate the intrinsic value of the company and only buy a stock when its price is below their calculation of value for the company. Growth investors typically do not calculate or care about the intrinsic value of the business and simply focus on its revenue and profit growth trajectory.
- All investors make mistakes, but the magnitude of the mistakes for a value investor is smaller than a growth investor.
TYPICAL VALUE STOCK
TYPICAL GROWTH STOCK
Good for investors who are:
Bargain hunters and Contrarians
Revenue and profit growth
Low to Medium
Value and Growth Traps
Investopedia defines a “Value Trap” as “a stock or other investment that appears to be cheaply priced because it has been trading at low valuation metrics, such as multiples in terms of price to earnings (P/E), price to cash flow (P/CF), or price to book value (P/B) for an extended time period. A value trap can attract investors who are looking for a bargain because they seem inexpensive relative to historical valuation multiples of the stock or relative to those of industry peers or the prevailing market multiple. The danger of a value trap presents itself when the stock continues to languish or drop further after an investor buys into the company.”
In contrast, “Growth Traps” are stocks that investors expect to keep soaring higher, but whose earnings may disappoint or negative investor sentiment about the stock causes the stock to drop precipitously.
Source: GMO Asset Allocation Team
The chart above shows that value traps have underperformed by 9.5% per year, while growth traps have underperformed by 13.0% per year.
Because both profits and mistakes of growth investors tend to be larger, growth strategies are usually more volatile than value strategies.
Value vs. Growth Performance
When looking at a longer period, value has done much better than growth.
Graph shows U.S. value stocks with a 10-year rolling average return.
Source: Bank of America Research Investment Committee, Fama & French
Over a 10-year period, anything in blue above is when value has outperformed growth, and anything in red is when growth outperforms value.
As you can see, value tends to do well most of the time, but during times of extreme market enthusiasm, such as before the bursting of stock market bubbles, growth tends to do well. It is during these periods when greed gets out of control and most investors no longer care about valuations.
Since 2008, world governments and central banks, especially in the US, have been stimulating economies and markets in an unprecedented fashion. As a result of too much money in the system, it has given rise to unrivaled market speculation. As such, value stocks have significantly underperformed growth stocks for almost the last 10 years now.
Source: Current Market Valuation
The chart above shows that we are still far off from normal and this is why growth is still trouncing value for the last 10 years.
In 2022, growth stocks were down a lot more than value stocks.
Value vs. Growth: Price % Change and Volume in 2022
If the amount of excess liquidity in the markets continues to normalize to pre-2008 levels, we believe that value stocks will once again beat growth stocks just like it has done historically.
Ultimately, your preference for value or growth investing depends on your specific mindset. If you care more about the potential returns rather than the possible risks, then growth investing is for you. If you want a strategy that is conservative when everyone is greedy and greedy when everyone is scared, then value investing is for you.
We believe every investment (and investor) should be assessed by their risk/reward proposition.
If one stock earned 10% per year compared to another stock that earned 8% per year, but the first stock had double the risk of the first, we believe that the second stock is the better investment from a risk/reward perspective.
We view investment managers the same way. Many things could happen over the long run, so we don’t invest in ETFs or mutual funds that have the highest returns. Instead, we invest in the ones that have the best risk-adjusted returns. We think you should too.
Please let me know if you have any questions or comments.
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