Growth vs. Value Equity Analysis and Action Plan

Source: Chart by BlackRock “Student of the Market” October 2020.  Based on Morningstar data as of 9/30/20.  Past performance does not guarantee or indicate future results. Index performance is for illustrative purposes only. You cannot invest directly in the index.

Value vs. Growth - Seeking Alpha 10/12/2020 Highlights

It’s the gift that keeps on giving (since 2006) for growth bulls and value bears. Don’t call it a comeback, but if you use a magnifying glass, you might be able to make out a little bump up in September 2020. It’s a blip on the radar. Value vs. growth has a lot of work to do.

(Some writers say the short-term moves towards value stocks so far may ultimately prove equivalent to the makings of a flash mob: fashionable in the moment, performs for a brief time, followed by a quick dispersal.)

From a valuation perspective, we expect the value-oriented equity sub-asset classes of the world to feature stronger returns than US large cap growth stocks over the next 5-10 years.  (But when will the shift start, as growth continues to shine vs. value?)

Value vs. growth goes through cycles that often last far-beyond what most investors can stomach in terms of relative losses. Just when value investors begin to throw in the towel, that is when value makes a comeback. We are looking for strong relative value in the space with macro catalysts – alongside a bullish turn in technicals. That trifecta can take many years to develop.

Bottom line: Value vs. growth could finally be closing in on a turning point.   Some of the catalysts  include higher bond yields, better growth, and stronger commodity prices.

Investment Management, Steward Report Highlights

A classic stock investing debate has long existed between those investors favoring more growth-oriented companies and those favoring companies selling at a large discount to a fair price, also referred to as value companies. Choosing between these two ‘competing’ investing styles is like choosing between cake and ice cream. Most of us really want both.

In a perfect world, an investor can find solid growth companies selling at a discount to a fair company value. Unfortunately, these deals are much more rare today than in 2009 after the real estate market’s collapse. In the stock market, we’ve seen an enormous and alarming disconnect between traditional growth-oriented companies and those that are of the value-style category.

Value Companies: Traditionally, accounts designed to provide a more stable, higher income and reduced risk profile would be classified as a more value-oriented investment approach. Value companies usually have mature business models that seek to maintain strong pricing power, modest growth, and typically reward long-term shareholders with a dividend payout or stock repurchases. 

Growth Companies: Growth companies are focused on higher revenue growth, expanding their market, and generally show lower profits due to higher investment in company expansion. They typically pay little to no dividends as they re-invest profits in expanding growth. 

At the right price, either value or growth can be very successful investments to own and can lead investors to long-term success. Both styles should be used in a well-diversified portfolio for balance and diversification. However, investor objectives may benefit from favoring one style over another.

A tidbit from Warren Buffet: “To invest successfully over a lifetime does not require a stratospheric IQ, unusual business insights, or inside information. What’s needed is a sound intellectual framework for making decisions and the ability to keep emotions from corroding that framework.”

The Glorious Backdrop for Growth - Investing.com - Highlights

Many have offered their take on why growth has outpaced value, pointing to the widening valuation spread between value and growth stocks, sector biases in value investing and lower-for-longer interest rates.

Financials and energy, which often hold the largest sway in value-investing strategies, are unlikely to make a comeback anytime soon.

Low interest rates, which have kept a lid on bond yields, have left banks struggling to turn a profit on loans and with the added pressure of Covid-19 related defaults, it's fast becoming apparent that money may be better invested elsewhere.

Energy, meanwhile, is down by more than a third over the past year, and notwithstanding the recent rebound in oil prices on output cuts, the crude demand story remains murky at best.

While the valuation spreads between value and growth stocks cannot continue to widen forever, there are not many who are betting on the global economy returning to rapid growth or interest rates breaking to the upside anytime soon.

In a low interest rate environment, growth stocks are "just mathematically worth more,” MFS strategist Rob Almeida told Barron’s. "So, the terminal value for a growth company is higher, because of the discount rate, than it is for a cyclical company."

Action Plan Recommendations

I can discuss individually specific recommendations based on one’s goals, objectives, and risk tolerance.

In general related to a total portfolio, I suggest investors have a diversified portfolio - often combining growth and value sector allocations -  using managers with long-term track records of outperformance compared to the category they invest in and the risk taken (Alpha vs. Beta in investment terms) – not just raw returns.  While the US has a significant COVID-19 risk, we have a comparatively stronger recovery potential than most global economies, even those who have done better in fighting against the virus.

US Small-Mid Caps often have the potential for faster growth, and with so many more smaller companies than large, good research can potentially find hidden gems.  Smaller companies' stocks are often more volatile with less trading volume but have rewarded investors over the long term.

I avoid “dumb” index funds with no stock selection based on individual company outlooks, or similar ETF’s (only make sense for traders, not investors). For those seeking income or for the more conservative allocation in a diversified portfolio, I suggest various bond alternatives, without the interest rate risk of many bonds at this point in the economic cycle.

Part of our "participate-yet-protect" strategy in a growth-oriented portfolio is to have alternative investments so that in a significant equity market decline when you also need cash, you do not have to lock in large losses in a market downturn.  Markets have always returned to new highs - only the timing is uncertain.

Required Disclosures:  Past performance does not assure future results. There is no assurance that objectives will be met. Investments in securities do not offer a fixed rate of return. Principal, yield, and/or share price will fluctuate with changes in market conditions, and when sold or redeemed, you may receive more or less than originally invested.  No system or financial planning strategy can guarantee future results.

Investors cannot invest directly in indexes. The performance of any index is not indicative of the performance of any investment and does not take into account the effects of inflation and the fees and expenses associated with investing.

The views and opinions expressed are as of the report's date and are subject to change at any time based on market or other conditions. The material contained herein is for informational purposes only and should not be construed as investment advice since recommendations will vary based on the client's goals and objectives. Information is believed to be from reliable sources; however, no representation is made as to its accuracy. Hutchison Investment Advisors, Inc. is an Arizona registered investment advisor. Part II of Form ADV (Disclosure Statement) has been given to advisory clients and is available upon request, and is also at http://dhutch.news/RIADisclosure