There are more than a few ways to categorize stocks, but one of the most popular methods is to divide them into growth stocks and value stocks.
Growth stocks are generally growing more quickly than the average company, while value stocks might have cooler growth rates but look fundamentally attractive on the basis of certain valuation metrics like the price-earnings ratio, price-book ratio, or PEG ratio, to name a few.
More aggressive investors tend to invest more frequently in growth stocks, while patient but perhaps more conservative investors often lean toward value.
Because of this, there’s an endless competition between growth and value stocks, and which segment is outperforming which. Every now and then, it’s fun to check in on which camp is winning — and why.
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Growth vs. value: The 2016 scorecard. It’s pretty simple: Value stocks are beating the pants off of growth stocks this year.
In 2016, the Russell 1000 growth index is up 1.1 percent and the Russsell 2000 growth index is down 1.9 percent. Basically, growth stocks are merely sideways this year — not quite living up to their name, it would seem.
Value stocks, on the other hand, certainly appear to have embodied their moniker at the beginning of the year. The Russell 1000 value index is up 4.7 percent while the Russell 2000 value index is up 7.5 percent to date.
But which are the better buys for the long term? How do you invest in growth or value stocks? How do you know when to buy one and not the other? And why is their performance so different in 2016 to begin with?
Reasons behind 2016 performance. “The big driver comes down to the sectors,” says Keith Lerner, senior vice president and chief market strategist for SunTrust Investment Advisory Group. “When you’re looking at the Russell 1000 value index, you’re seeing energy, which is the top sector this year, is the second-biggest sector in the index.”
Why, then, has energy itself gone up?
“Part of it is because the (energy) stocks got so inexpensive and commodities have risen, that you’ve gotten this whole value trade,” says Mary Ann Bartels, head of portfolio strategy for Merrill Lynch.
But it’s not just energy that’s been creating the disparity between growth and value stocks this year.
“If you look at the utilities sector, it’s the second-best performing sector, and that tends to have a much heavier weight in the value indices,” Lerner says. Utilities stocks tend to pay higher dividends, and dividend investing has also been in vogue in 2016.
Not helping things for growth stocks is the fact that health care, a big component of growth indices, has been the worst performing sector in the market this year.
Growth vs. value: Long-term performance. So value has beaten growth in 2016, that much is established. What about in the longer term? It turns out value wins there, too.
The world’s most famous value investor, Warren Buffett, is widely considered the best investor of all time.
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Bob Johnson is the co-author of “Strategic Value Investing,” a book that Warren Buffett put on his reading list for the 2015 and 2016 Berkshire Hathaway annual meetings. So Johnson knows a thing or two about this subject.
“Value stocks tend to outperform the overall market over long time periods,” Johnson says. Between 1926 and 2012, value stocks outperformed growth stocks 14.7 percent to 11.2 percent — or 3.5 percent annually. Due to compound interest, that makes an enormous difference.
But why do they outperform?
“The biggest reason is that value investing requires a contrarian bent,” Johnson says. “Successful value investing requires independent thought and going against the herd. Value investing isn’t sexy, as you aren’t going to have a portfolio of high-flying stocks.”
Although as both Buffett and history show, they will be flying high if you just give them enough time.
“A big advantage that Buffett has is that he’s patient. He knows that he has a cheap asset, he just doesn’t know exactly when that will be rewarded by the market,” Lerner says.
Growth versus value: Cycles. “Growth and value have cycles. There’s periods where value works, there’s periods where growth works, and when one is working the other is not working,” Bartels says.
“What you need to do to be successful over time is stick to your discipline. That’s what Buffett has done over time. That’s one of the keys to successful investing: sticking to your strategy.”
That’s an important concept: value does not, by any means, always outperform growth. In fact, over the last 20 years, growth has beaten value, and in the 1990s growth stocks demolished value stocks, beating them by about 6 percent a year.
The principal of reversion to the mean, however, holds that over time outperforming pockets of the market will pull back and underperform in the years ahead, ultimately reverting to their long-term averages.
So paying attention to the growth versus value race isn’t just an interesting thing to track. It can be profitable, in theory. The concept of mean reversion, says Lerner, “does help somewhat because these value and growth cycles tend to be measured in years, not months. And you often see big performance differentials between growth and value.”
As with most good things in life, though, there’s a caveat.
“Reversion to the mean can tell you potentially the magnitude of a move but not the timing,” Lerner says.
How to invest in value stocks and growth stocks. Want to track the Russell value and growth indexes, some of the more commonly quoted barometers of value and growth stocks, in your own portfolio? Easy. You can buy low-cost funds or exchange-traded funds to track them, just like you can for the Standard & Poor’s 500 index.
There are a few options, but there’s a lot to like about the brand reputation and the low fees of the Vanguard fund family.
The Vanguard Russell 1000 Growth ETF (ticker: VONG), Vanguard Russell 1000 Value ETF ( VONV), Vanguard Russell 2000 Growth ETF ( VTWG) and Vanguard Russell 2000 Value ETF ( VTWV) all track their namesakes.
The iShares Core Russell US Growth ( IUSG) and iShares Core Russell US Value ( IUSV) are also two solid options, both tracking their Russell 3000 equivalents. IUSG and IUSV are up 1 percent and 5.5 percent, respectively, in 2016.
At the end of the day, value takes the cake. Just remember that if you decide to go with value stocks, they likely won’t rack up huge profits overnight, and they may underperform over the next several years.
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But over the long run, if history is any indication, they should beat growth stocks by a mile.
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Growth Stocks or Value Stocks: Which are Winning? originally appeared on usnews.com
