Value Still Beats Growth

Back in 2015, we wrote an article entitled Value Beats Growth, referencing the fact that the value style of investing had better results than the growth style over long periods of time. In that article, Benton Bragg made the case that “all that glitters isn’t gold.”

Fast forward seven years and we find that all that glitters still isn’t gold. And yet, many investors keep forgetting the painful “dot-com” bubble burst experience and simply can’t resist chasing after returns. 

As a quick refresher, a growth stock typically has a high rate of sales growth or earnings growth. Growth companies often have a new product, service, or technology about which investors are optimistic and, in many cases, super excited. The most important thing to remember is that growth stocks trade at premium valuations based on measures such as the price-to-earnings ratio (P/E) or price-to-sales ratio (P/S). Growth investors are future-focused. A growth investor justifies paying a very high price for a company today while counting on the sales and earnings of a company being much higher in the future. Growth stocks are sometimes called momentum stocks because a rapid increase in the price of a stock attracts the attention of other investors who load up on shares, driving the price even higher. In many cases, expectations are unrealistic and the price overshoots. When investors finally sober up and those expectations are shattered, a growth stock can crash hard. Even with its volatility, growth investing has delivered good returns over the long term. 

In contrast to growth investing, value investing focuses on buying stocks of companies with proven business models and strong balance sheets at reasonable prices. Value investing is more focused on the here-and-now instead of being so focused on the future. A value investor might ask, “What are the earnings of ABC company today and what multiple of those earnings am I willing to pay to own a share?” Value stocks tend to trade at more modest valuations. The value approach to investing has also delivered good returns over the long term and has done so with less volatility.

Over the last ten years, growth outperformed value. Thanks to the longest bull market in history and a very accommodating Fed (the Fed has kept interest rates extremely low), investors became enamored with growth stocks yet again. One doesn’t have to look further than the popular “stay-at-home stocks” like Peloton, Zoom, DocuSign, and Roku, to name a few. When the pandemic hit and it was obvious that we would be locked down at home for an extended period, these stocks skyrocketed as investors piled in. Valuations were high and expectations seemed to imply the stocks would go even higher. Does that sound familiar?

Well, the music did stop, and the party did end. Growth stocks have led the market decline so far this year. For the last five months, value has replaced growth as the leader. At the time of this writing, the return from their peak for Peloton is -87%, Zoom is -81%, DocuSign is -69%, and Roku is down 77%. The table below shows that while growth led from 2016 to 2021, it is now value that is leading.

Speaking of holding up well, check out the chart below. The chart shows yearly premiums calculated as the difference in one-year returns between Fama/French US Value Research Index minus the Fama/French US Growth Research Index. Despite growth having a good run lately, value stocks have outperformed growth stocks in the US by an average annual value premium of 4.25% since 1927. Another thing to notice in the chart is that value premiums have often shown up quickly and in large magnitudes. The average premium was over 14%.

Click image to enlarge chart

History demonstrates that it’s a fool’s errand to try to predict which investing style will lead next, be it next week, next year, or the next decade. And fortunately, we don’t have to make that bet. As mentioned earlier, both the value and the growth approach have done well over long periods of time. Sometimes value will lead, while at other times, growth will lead. By owning both value and growth in the portfolio, we gain diversification and participate in market gains (and losses, of course), regardless of which style is in favor.

Bragg portfolios own value and growth, but because long-term historical evidence demonstrates that value has higher risk-adjusted returns than growth, our portfolios do tilt toward value. You can see the historical evidence in the table below. Over a span of 40 years, value has either performed in line with or outperformed its growth counterpart and has done so with less volatility.

Another way of describing our approach is to say that our portfolio is slightly more defensive than the market. Our goal is to preserve your capital in down markets while participating in the upside during bull growth markets, knowing we may slightly trail the major benchmarks when the growth stocks get frothy. Over full business cycles, we expect to perform in line with the market while taking less risk. Most importantly, we stay humble and recognize that we do not have a crystal ball to see the future. Instead, we focus on putting together a portfolio that is appropriate for your financial situation. We then rebalance with discipline and keep our emotions in check.

This information is believed to be accurate but should not be used as specific investment or tax advice. You should always consult your tax professional or other advisors before acting on the ideas presented here.