Apple,
Microsoft, and Amazon each have a market cap in excess of $1 trillion. Why? In
part because these companies have kept a steady eye on growth.
Meanwhile,
Warren Buffett, considered by many to be the greatest investor of our time, has
amassed a personal fortune of $73 billion. Why? Because he’s kept a steady eye
on value.
Growth
is typically defined by earnings per share (EPS) and sales per share (SPS).
High growth rates often drive higher “earnings multiples,” meaning investors
show a willingness to pay more per unit of current earnings, with the
expectation that growth should eventually “catch up,” so to speak.
How
do investors typically measure these so-called “multiples?”
·
Price-to-earnings
ratio (P/E). Basically,
this is a company’s stock price divided by earnings per share. It could be
based on the past 12 months’ earnings per share (“trailing P/E”) or on the
company’s projections (“forward P/E”).
·
Price-to-book
value ratio (P/BV or P/B).
This is the stock price divided by the stated value of its net assets (total
assets less intangible assets and liabilities).
Growth
stocks tend to show up in fast-growing industries like technology,
pharmaceuticals, and other modern industries. Think of “FAANG” stocks: Facebook
(FB), Apple (AAPL), Amazon (AMZN), Netflix (NFLX), and Google parent Alphabet
(GOOGL). These are among the classic growth stocks of our day.
Conversely,
value stocks typically have low P/E and P/B ratios and lower expected growth
rates. Financial companies, automakers, and commodity producers are often
priced at low valuations, and thus get called “value stocks.”
If
you’re looking at individual stocks, consider looking first at the industry. Is
it associated with growth? Next, consider the P/E and P/B ratios. Here’s one
common rule used by some analysts: if the P/E is above 20, and/or the P/B is
above 3.0, it’s probably a growth stock.
As
bad as the pandemic has been, and as much as the economy has suffered, no
crisis lasts forever. This might give value a fighting chance versus growth as
the world emerges from this unprecedented period. The so-called “growth-value”
spread recently hit levels last seen two decades ago during the dot-com boom.
When spreads reached historic levels, it can often point to a change in the
weather.
The
chart shows only through December 2019, but the growth side continued to
accelerate in the first half of 2020 as FAANGs, biotechnology firms, and
semiconductors gained ground.
FIGURE: GROWING GROWTH? Over
long periods, both growth and value have had periods of outperformance. But in
recent years, growth has been the clear winner. Data source: MSCI.
Another way to track how they’ve performed differently, as
mentioned earlier, is to compare P/B ratios. About a decade ago, the average
P/B for growth stocks was around 4, versus around 1 for value stocks. Today,
P/B remains around 1 for value, but it’s zoomed up to around 8 for growth.
That’s the highest P/B for growth since 2000.
Growth likely benefited recently because so many investors
wanted large, familiar names that had weathered challenges like the 2008
recession and a 2015–16 “earnings recession.” But you could argue the move
reflected a scramble away from value as much as one toward growth.
As the economy reopens, people are getting back out again,
but growth stocks keep making new highs. COVID-19 is viewed by most economists
as a temporary shock to the economy. With many predicting improved conditions
in Q3 and beyond, will growth stocks continue their climb?
It’s a complicated picture, to say the least. Academic
financial gurus Eugene Fama and Kenneth French famously declared value (in the
form of low P/B ratios) to be one of the best factors for stock selection. But
their subsequent research suggested that growth factors of profitability and
reinvestment may be very similar in impact to value factors. It’s uncertain
which matters more statistically.
Believe
it or not, some of today’s steady dividend cash cows were once the upstart disruptors.
Consider IBM, which has a dividend yield of more than 5%. In the 1960s, IBM was
part of the “Nifty 50,” which also included stocks like General Electric (GE)
and Johnson & Johnson (JNJ). Those companies were arguably the Apple and
Tesla (TSLA) of their day.
So.
when it comes to choosing growth versus value, it’s hard to say definitively
which one is better. It may come down to your objectives:
·
Are
you looking for potential income?
·
What’s
your time horizon and risk tolerance?
Today’s
highflier may be tomorrow’s low-P/E, dividend-paying value stock. Plus,
investing doesn’t have to be an either-or, vanilla-or-chocolate, heads-or-tails
decision. Choosing a mix of growth stocks and value stocks can help you build a
diversified portfolio.
Reference:
1. Viraj Desai, Growth vs. Value Stocks:
Which Is Right for Right Now? https://tickertape.tdameritrade.com/
2.
Kelly
Bogdanova, Growth versus value investing in a Covid-19 world https://www.rbcwealthmanagement.com/
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