Value or growth? It is a dilemma that many investors are struggling with when choosing their portfolio. In addition, fund managers capitalize on the distinction of offering dozens of thematic funds. Some investors are so rigid that they either go all the way for one camp or all the other. What is the difference?
With value shares you mainly pay for what is already in the company. For example, you are looking for a company that is worth 100 euros according to the book value, but for which you only pay 70 euros on the stock exchange, in the hope that the market will see the potential of the company in the long term and the fair price will stick to it. In growth stocks, you pay mainly for the future earnings that you hope the company will drive in. It is as if you now put 100 euros on the table to harvest 200 euros within a few years.
Value stocks are usually much cheaper than growth stocks. They are quoted cheaper against the turnover and profit they make and against their book value. The major US growth stocks are trading at 27 times their earnings, the value stocks at 17 times. “Globally, the price-earnings ratio for growth companies averages 22 versus 13 for their value counterparts,” said Christian Schmitt, Ethenea’s portfolio manager. “That is a premium of 70 percent, while the historical average fluctuates around 40 percent.”
Higher dividend yield
Value companies usually also deliver higher dividend yields, as they keep less money aside to invest in growth projects. Growth companies usually want to keep a larger share of any profits in the company to finance their growth trajectory. In the very long term – since 1900 – value performs slightly better than growth. Value stocks outgrow growth stocks, especially during recessions. But not during the latest bear markets. The reverse happened there.
Both during the financial crisis in 2008-2009 and in the current corona crisis, growth stocks far outperform their counterparts. Since the New Year, the growth stocks from the US S & P500 index can show an average price gain of 5 percent, while the value stocks dangle 15 percent lower. The Nasdaq Composite Index packed with growth companies
even rose for the first time this week by the mark of 10,000 points.
Growth stocks (+ 254%) have outperformed value stocks (+ 78%) since the previous major market peak in 2007, and are still nearly double that since the trough in March 2009. The explanation can be found quickly. During the financial crisis in 2008-2009, the banks, which weigh heavily in the indexes of value shares, were the cause and therefore also the waste. And during the current crisis, technology companies, which make up the bulk of the growth indexes, are benefiting from the high levels of home work, booming online commerce and their resistant business. Technology is the big winner of the pandemic.
Many American tech companies are still interesting. The situation is not comparable to the tech bubble in 2000.
“Growth has exceeded value for 13 years,” summarizes Randeep Somel, portfolio manager of M&G Investments. “Due to the persistently low interest rates, investors worldwide are looking for growth stocks. Then you automatically end up with the American tech companies, even the smaller ones, which show very strong growth. Not only do they grow with the market, but they also decrease the market share of others. We can divide the investor universe into the “disruptors” – those who disrupt the market – and the “disrupted” – those who must suffer the disruption. This largely corresponds to the difference between the growth and value shares. As long as interest rates remain low, growth should continue to perform better. ”
However, a limited sector rotation has started in recent weeks. Banks, industrial sectors such as cars and steel, and energy companies performed better than the market average. Optimism about a rapid economic downturn and central bank money injections caused investors to seize the most backward sectors. Against the defensive pharmaceutical industry, banks performed a quarter better in the past three weeks. Yet there is no reason to think that it is a structural catch-up move. “In the short term, the enormous valuation gap may narrow somewhat, now that the economy does not seem to be heading for the worst scenario. But in the long run, the more favorable trend for growth stocks will continue, “Schmitt thinks. “The new competitors are limiting the potential growth of today’s value stocks. That raises questions about the intrinsic value of their business. In a scenario of stagnant or even falling intrinsic values, many value stocks remain unattractive and will end up as “value traps.”
“Value stocks are dirt cheap versus growth stocks. But what’s cheap can get even cheaper. The time to choose value over growth has not yet come, “said Vincent Juvyns, strategist at JPMorgan Asset Management. “In the first place, the banks should excel for that. With a weight of 20 to 25 percent, they form the heavyweight in the Value indexes of the index calculator Russell. We don’t see that happening. Higher inflation and higher interest rates are necessary for a structural price recovery of the banks, because banks earn little money at low interest rates. The central banks will keep interest rates very low for a long time. And we do not see a risk of inflation. The oil price has risen somewhat, but is not inflationary, as demand remains substandard due to the sharp fall in traffic and the weak economy. As a result, we do not see the oil sector, another heavyweight in the Value indexes, performing better. We see no catalysts for choosing value stocks. ”
Juvyns prefers Wall Street and the Chinese stock exchange because it houses more technology companies. “That is also the big explanation why the American stock exchanges perform much better than the European ones. If you calculate Wall Street without the technology and Europe without the banks, the stock market performance is identical (see graph). ”
The JPMorgan strategist points out that, with a few exceptions over time, technology has almost always been expensive, but performs superior over time. “Current valuations in the technology sector are justified on the basis of future earnings. Microsoft noted in the late 1990s
at an insanely high price-to-earnings ratio of 99. But even those who got in then did a golden thing. Although it was of course even better if you had bought the share in 2009 at just 9 times the profit. ”
Juvyns emphasizes that a strict distinction between value and growth is not ideal as a strategy. “There are good and bad companies in both domains. It is much too early for style investing. You have to look at the strong individual stories, and they can be found in every style. “That’s also the view of Ron Temple, head of US equities at Lazard Asset Management:” The debate between growth and value stocks is a false choice. A company can perfectly combine both. Look at Alphabet
: The internet giant over Google is cheap at the same time with many value features and is growing rapidly. ”
As long as interest rates remain low, growth stocks should continue to outperform value stocks.
“A lot of American tech companies are still interesting,” says Temple. “The situation is not comparable to the tech bubble in 2000, when many expensive technology companies faced low cash flows and weak balance sheets. Now many big tech companies show off balances as solid as a rock and strong, sustainable and growing cash flows. In the corona crisis, they have been able to emphasize their competitive advantages even more. Investors are willing to pay more for such quality. “” The past 40 years have taught us that you should not choose between growth or value, but quality, “Temple summarizes. “Rather search for companies with a strong and sustainable return on equity. They perform better. ”
The long-term low interest rates make investors willing to pay higher valuations for future profits. Therefore, Temple believes that the valuation ratios of growth companies and companies with predictable cash flows and high dividends could be even higher. He is skeptical of a number of banks and utilities because of their low return on equity, the traditional energy players because of climate change, and the makers of consumer products because they are relatively expensive. He also sees Wall Street shining further.
“My big fear is that the US is not tackling the corona crisis badly, so new lockdowns are needed. In some states like Florida and California, the number of infections is increasing. But the unseen incentives from the Federal Reserve and the government provide compensation. Europe, too, can finally budge as the European Central Bank does more, and even the political leaders in Germany seem to accept the joint issue of bonds. That could be a structural game changer in Europe. ”
Punished too heavily
Damien Lanternier of the French asset manager DNCA Investments also sees something in Europe. Unlike most other analysts, he predicts an imminent catch-up in value stocks. “The valuation gap has become too large. We prefer financial institutions. They have been punished too heavily, while the economy does not seem to be heading for the worst scenario. Many European telecom shares are also valued very low, while their results resist well in this crisis. ”
The debate between growth and value stocks is a false choice. A company can perfectly combine both.
However, he does not rule out the possibility that the valuation gap could also be closed by a greater decline in growth shares. In general, DNCA is very careful because the growth rate cannot but slow down. Caution trumps applies to almost all stock exchange houses and asset managers. Fears of the virus’s flare-up remain high, and it is uncertain how quickly or to what extent the economy will recover even thanks to the stimuli. People and companies should not only be able to spend money but also want to spend it. And that is less evident than ever in these corona times.