Current Thinking

Growth Stocks Have Overtaken Value Stocks and the Gap Has Been Getting Wider

Most financial analysts and economists believe that a company’s profits, dividends and business growth over time (i.e. the company’s fundamentals) should be the key determinants of that company’s stock price and its movement up or down over time. The idea that a company’s stock price should be driven by its fundamentals, that is, by its cash flow, profits and dividends, was reflected in the work of Benjamin Graham, who was considered the “father” of value investing. He believed that if the current price of a stock is below its fundamental or, true value, positive returns can result from the stock price increasing to its true value. Value, as a style of investing, has also been considered a pillar of active portfolio management, whereby investors can beat the market over time by identifying stocks with high dividend yields (where dividend yield equals dividends divided by price) and steady profits.

However, whether it’s due to the dominance of the internet and the big tech stocks, or changes in the way market information is transmitted to investors, it appears as though the actual level of share prices relative to company’s longer term fundamentals have become less critical to Wall Street and investors. Significant quarterly and yearly growth, whether in net income, cash flow or revenues, has been consistently rewarded by the stock market. The table below shows that historically, value stocks (such as energy, financials and consumer staples) have generated higher or fairly comparable returns versus growth stocks (technology, health care) over significant time intervals. However, there appears to have been a paradigm change, as growth stocks have significantly outpaced value stocks since 2010 and particularly so over the last several years.

Value Stocks % Return (Annualized) Growth Stocks % Return (Annualized)

12/31/1979-12/31/2000 12.1%   13.4%

12/31/2000-12/31/2010   3.2%    0.0%

12/31/2010-7/23/2019    11.1%   14.7%

12/31/2016-7/23/2019   8.4%   20.4%

Source: Bloomberg

The “growth regardless of price” mantra fueled by lower taxes, stock buybacks and market share (i.e. very few companies comprising a dominant share of its industry) have been driving the overall stock market. In 2017, if an investor or asset manager did not hold Facebook, Amazon, Apple, Netflix, Google (Alphabet) and Microsoft (the FAANGM stocks), they would have missed out on 25% of the S&P 500 Index’s gains that year. Of course, the opposite can be true over the short term when the market corrects and the FAANGM stocks are impacted by tariffs and regulatory scrutiny. In May 2019, the tech-heavy NASDAQ 100 Index declined by -8.2% while the S&P 500 Index fell by -6.4%.

Will value investing close the return gap at some future point? One would believe that growth has so outperformed value in recent years that a limit has to be reached, generating some reversal to parity when growth stocks finally become too expensive. A prolonged market correction may also increase awareness of price and value while reversing the momentum of growth stocks. Since it is nearly impossible to predict turning points, diversification and lowering risk is an argument for investing in both growth and value styles.

NOTE: Information presented herein is for discussion and illustrative purposes only and is not a recommendation or an offer or solicitation to buy or sell any securities. Past performance is not a guarantee of future investment results.