For a basic explanation of value v growth stocks skip below the chart
- The chart below shows the 3-year performance spreads between Growth and Value have reached levels last seen at the peak of the dot.com bubble
- Kailash has documented the precarious valuations of many popular growth firms in quick takes to a barrage of recent research
- With the chart rolling over hard, Growth Investors might be well served to begin exiting the most speculative of growth stocks
If the future rhymes with history, we know the exits from such speculative extremes can become anything but orderly as the fallout from the prior peak saw growth decline 62%. For those interested in investing based on buying healthy companies with long histories of selling products at healthy profits please contact us here.
Growth and Value Stocks Explained Simply
The views here are designed to be broad and simple generalizations for novice readers. If you would like detailed research on the topic from our favorite books on the topic to some of the best peer-reviewed academic research, please reach out to firstname.lastname@example.org. Unlike many who view these as two distinct investment styles, KCR actually believes they are intrinsically linked. Search “growth” or “value” on our site and you will see this is something we have discussed at length in many of our Quick Takes and White Papers.
Growth Companies: generally speaking, these are firms that prioritize earnings growth over long time horizons. People who invest in growth stocks often expect these stocks to experience elevated rates of sales growth over a prolonged period of time. Many growth indexes identify growth stocks based on the presence of higher price-to-earnings ratios and other elevated valuation metrics like price to book. For example, if you look at the Russell 1000 Growth ETF you will see it has a P/E ratio of nearly 45x and a P/B ratio of 14x.
Value Stocks: generally speaking, these are firms that are established, profitable, and slower growing or have lower expected growth than their “growth” peers. These stocks often have market capitalizations that are modest relative to traditional measures of valuation. If you look at the Russell 1000 Value ETF you will see it has a P/E ratio of 24x and a P/B ratio of only 2.6x – an enormous discount to the growth index. Academic literature as well as KCR’s own research has established that, over the long haul, value stocks have outperformed growth stocks.
Thoughts Worth Considering:
When an investing strategy embeds long term expectations in a stock price like growth investing often does, it can lead to larger gains and larger rewards over the short term. This is something we discussed in our piece Who is the Next Amazon? and many others. One of the benefits of owning stocks and value stocks in particular is that, over very long horizons, they have tended to outperform bonds.
KCR has pulled no punches in its research process. We believe that with valuations on the broad S&P 500 well above the records seen at the peak of the dot.com bubble, the risks to investing in US stock markets are high. We do believe the selective ownership of mutual funds that specialize in buying high quality companies at reasonable to cheap prices represent an attractive option for long-term investors.
As we have documented, there have been terrific opportunities to buy Small Cap, Mid Cap, and Large Cap Quality companies at modest prices. We have also highlighted the many opportunities we believe exist in some of the safest stocks that also happen to sport healthy dividend yields.
Conversely, we have highlighted what we believe are the serious and growing risks of investing in “innovation” stories and highlighted opportunities in supposedly dead industries like energy. KCR’s research team believes that, in many ways, today’s markets have gone off the rails.
We believe promotional CEOs, newsletters, and portfolio managers are encouraging retail investors to chase performance of some of the most fundamentally weak firms we have seen in our many decades of investing. Where others make grand promises, KCR encourages caution and is committed to the traditional methods of investing that have proven themselves out over centuries of human history. We do not believe it is different this time. We believe history rhymes and that our deep roots in Behavioral Finance will serve us well in the decades ahead.
For those interested in finding investing strategies with historical merit that emphasize safety and income we may be a great service for you. As always, we are grateful for any interest. These are exciting times, but we also believe that same excitement is the reason to be fearful when others are greedy!