Rick Welch: Dollars and $ense

Value or Growth?

As an investor, do you like having more choices or less?  In choosing a stock or stock fund for your portfolio, the first step in the decision making process is typically to focus on market capitalization or market cap (large, mid or small).  After market cap, the next step is often to consider style with the two most common style approaches being value and growth.  At this point, you are probably thinking that the terms, value and growth, are simple enough to avoid confusion in the marketplace.  While the characteristics that distinguish the two styles are derived from the same data, there are other factors which can blur the lines between what value and growth should mean to the investor.

Fundamentally, value and growth investing appear to be quite different.  Value investing targets companies with lower-than-average growth rates for sales and earnings and lower-than-average price-to-earnings (P/E) and price-to-book (P/B) ratios. Typically, value stocks also pay a higher dividend yield.  With value stocks, we are often looking at disappointing past results.  In some cases, the period(s) of poor performance are considered temporary and suggest that a turnaround opportunity may exist.  Some investors mistakenly equate value with cheap.  In some cases, stock prices are lower because the company has consistently disappointed investors – in this instance the stock price may be cheap, but not because there is hidden value, rather because there is little demand for the stock.

Growth stocks point to a promising future, with less attention paid to past results.  In contrast to value investing, growth investing targets higher-than average growth rates for sales and earnings and higher-than-average P/E and P/B ratios.  In most examples, lower or no dividends are paid to shareholders.  The trade-off for investors who like dividends is that growth-oriented companies are more likely to reinvest profits in the building or expanding of their business thus creating greater value in the ongoing enterprise. As you might expect, growth stocks are more susceptible than value stocks to both earnings disappointments and surprises. 

So which style is right for you and your portfolio?  Value and growth stocks tend to move into and out of favor over time, so a good strategy might be to own both styles in a diversified portfolio.  During recessions and the first steps of post-recession recovery, value stocks will often outperform growth stocks.  During expansionary times, growth stocks are often the leaders. During 2013, we saw a gentle rotation from value to growth during the spring and summer quarters. For the year, the S&P 500 Value Index returned 25.17% compared to a return of 28.41% for the S&P 500 Growth Index.  The top three companies in the Value Index are General Electric, Chevron and Berkshire Hathaway.  The top three companies in the Growth Index are Apple, Google and Exxon Mobil. As an example of stocks moving between value and growth, Johnson and Johnson is listed among the top ten companies in both the Value and Growth Indices.

The savvy investor must acknowledge that in the valuation process value and growth are, in fact, related to each other, not separate and distinct styles or characteristics. In his 2000 annual letter to the shareholders of Berkshire Hathaway Warren Buffett wrote that “investment managers who refer to “growth” and “value” styles as contrasting approaches to investment are displaying their ignorance, not their sophistication. Growth is simply a component – usually a plus, sometimes a minus – in the value equation.”