Chart of the Month: Extreme Market for Growth Stocks

Price-Value Scale

Growth stocks—generally, stocks of companies with above-average revenue growth and strong returns on equity—have had a superlative year so far. In fact, they have done very well since the Great Recession almost ten years ago.

In contrast, Value stocks—typically, stocks of companies trading at a discount to the market, often paying a dividend—have really struggled this year. And, while they have had short bursts in performance, they have often lagged in recent years.

Is it always this way? Does Growth always win?

Growth-Value Differential

The chart above shows the difference in performance between Growth Stocks and Value Stocks for the past 30 years[1]. When Growth is beating Value, the blue line moves up. When Value is beating Growth, the blue line moves down. The grey and red lines mark meaningful extremes.

Some key points:

  • Growth and Value tend to move in broad cycles that can last years. Incidentally, there are other, less dominant investment styles too, such as Momentum and Quality.
  • Growth dominated during much of the 1990s, culminating in the Tech Bubble where Growth exceed Value by an EXTREME level. It then collapsed quickly, with Value taking the lead for much of the next decade, hitting an EXTREME in 2010, when cheap stocks surged after the Great Recession.
  • Since that time, Growth has generally beaten Value—and at an accelerating rate over the past two years, to the point of another measurable EXTREME.

Prior to the market decline in October, the best Growth stocks were trading at an average P/E multiple of 121-times earnings. Many of these are great companies, but expectations for future growth are extremely high. It is often difficult for companies, as a group, to match these outlooks.

In contrast, the cheapest Value stocks are trading at less than 10-times earnings, compared to the market’s 20-times.

Where would you position yourself for the best potential returns?

A final few points:

  • Timing these cycles is difficult. Only in hindsight is the timing clear. That said, we want to recognize extremes and adjust portfolios as our models suggest.
  • While we follow the Value style, our research approach is diversified to include criteria of fundamental improvement. We don’t just buy “cheap stocks.”
  • As a case in point, our strategy performed well in 2016 and 2017 vs. the S&P 500, at a time when Growth was doing well. This year, however, the current winners are beyond the reach of our discipline. We would have to abandon our long-standing approach to win in today’s market—perhaps gaining a short-term boost but potentially jeopardizing long-term performance.

The bottom line here is that investors often tend to invest in what is working. The Growth style has been building steam for some time. But as this chart shows, investment styles ebb and flow, at times in unpredictable ways—yet extreme positions are unsustainable. Success requires discipline and patience—and recognizing that “this time” is rarely different.

[1] We use the Russell 1000 Growth Index and the Russell 1000 Value Index for this analysis.

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