If someone asked you Value or Growth, how would you answer? What considerations would you make in coming to your answer? And would you be justified in deciding this? Well for most investors, these decisions are not made by them, but instead by their Financial Planner. My question is, how are THEY coming to this conclusion?
When considering a factor portfolio construction, the two major categories are value stocks and growth stocks. In the stock selection process, stocks are usually classified into these two groups, and depending on the stocks, further variations such as GARP (Growth at a Reasonable Price) or Income can be attributed.
Growth stocks demonstrate high growth characteristics, which include (but not limited to):
- Being priced higher than the broader market
- Having higher earnings or revenue growth records
- Being less sensitive to economic conditions relative to broader market
Value stocks are stocks that are under-priced relative to the market, and often rely on fundamental analysis to make such a comparison, its characteristics include (but not limited to):
- Being priced lower than the broader market
- Currently priced below similar companies in the industry
- Able to carry more risk than the broader market
Value and growth stocks performs differently in distinct market conditions. As shown below, the returns of growth stocks (represented by MSCI Australia Growth Index) are vastly different to the returns of value stocks (represented by MSCI Australia Value Index) at different time periods.
History suggests that the market cycle is a large component to this discrepancy, with value stocks outperforming when the market peaks and pulls back from expensive levels. In these conditions, higher priced growth stocks under-perform and investors flock to the defensiveness offered by cheap valuations.
We also observe that over time, growth outperforms value on an average basis. The bull market from 2003 to 2007, and 2014 to 2018, showed the strongest out-performance of growth stocks. However, recently there has been a shift to value out-performance since a few months ago, and as market conditions look to change again from the low interest rate environment globally, this might be the beginning of a long-term reversion back towards the out-performance of value stocks.
So next time somebody asks you whether you prefer Value or Growth, give them an explanation that’s worth investing in.