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Pitting growth against value

Rebecca Cretney explains that Brexit may be hitting UK headlines, but it is not a global theme for investors to worry about unless their approach to wealth management has left them exposed.
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Published 14 May
5 mins
The financial press love to talk about ‘the strength of the US market’. And with good reason, as it really has been staggeringly strong. If you compare US equities to a basket of other developed market equities, US stocks are at their highest level in over 50 years. Aside from the internal problems some of the other ‘developed nations’ in our basket face (Europe’s fragmentation or Japan’s age problem, to name but two), there are a number of reasons that explain the US’s massive outperformance. US policies being far more supportive of growth and the strength of the US dollar are two, but the reason I would like to zone in on is that the US market is more oriented towards growth stocks than other markets.

But what are growth stocks, what are value stocks and why is this important? We recognise that wealth managers are prone to jargon and, over the past months, in the webinars and articles we have been providing, we have often spoken about growth and value stocks without pausing to take breath and explain what we mean by these terms. This article is that pause.

Why is this important? Because, taking this year in isolation, the gap in performance between the MSCI growth and value indices has grown to an astonishing 17% (as at the time of writing). That is an extraordinary difference, which is worthy of comment and shows what investors are seeking out.

Growth and value are basically two approaches to investing in stocks and shares. Essentially, growth investors are looking to invest in companies that offer strong earnings growth. Value investors, meanwhile, are looking for stocks that appear to be undervalued relative to their worth according to their balance sheet (or in other words, a bargain because of their perceived value now, not their future growth potential). It’s a bit like the hare and the tortoise, except in our story it is the market conditions that tend to determine who wins (and so far the hare has won most races).

Growth stocks are companies that have had better-than-average increases in earnings and profits in recent history, and are expected to continue on this trend. This makes them very attractive and so they tend to be priced at a higher level than the broader market. Investors are willing to pay the inflated price-to-earnings multiples on the expectation of future growth, enabling a later sale at even higher multiples. History has shown that this earnings growth can come despite what’s happening in the economy, and history has been repeating itself recently.

Growth stocks, however, do tend to be more volatile than the broader market. The risk is that the price could fall sharply on the back of negative news that could impact investors’ earnings expectations for the company.

Value investors, meanwhile, are looking for companies that have fallen out of fashion, but still have good underlying fundamentals. This type also includes the shares of companies that have yet to be noticed by investors because they are new, or merged with a peer company to become more competitive. Because they are out of favour, value shares tend to have a lower price than the broader market, but – as investors seek out ‘good’ companies – the expectation is that they will bounce back in time, when the true value is recognised by other investors, or when the issue behind the company’s problems (disappointing earnings, negative publicity or legal problems, for example) fades or disappears.

Value stocks tend to carry less risk than the broader market, because the bad news is already priced in, but most bad news takes time to turn around, so these stocks tend to be more suited to longer term investors.

As with anything to do with investing, however, life is not simple. There is a continual debate over which style – growth or value – should produce better returns over the long term. Some studies, for instance, have shown that value investing outperforms growth over extended periods of time on a value-adjusted basis. Given the short-term focus of many investors who want to get rich quick, value stocks are ignored in favour of their brash growth peers and, as prices fall to new low levels, there are greater buying opportunities for value investors.

Other studies have also highlighted that growth stocks, in general, have the potential to perform better when interest rates are falling and company earnings are rising. Value stocks, meanwhile, are often stocks in cyclical industries, which may do well early in an economic recovery, but typically struggle to maintain that momentum in a bull market.

So what should investors do? Diversify. Although we currently have a bias towards growth, it is marginal and a product of the uncertainty we are living in. Value stocks tend to be more cyclical (see our recent article highlighting our focus on defensive stocks). We currently favour the higher quality option, which tends to be growth companies such as Mastercard, whose revenue should not be hugely impacted by COVID-19 in the medium term.

Ultimately, however, when the economic cycle changes we may shift that weight. Value stocks have historically delivered when stormy market conditions start to dissipate and economic growth reasserts itself. Does this mean we will ditch growth in favour of value? No. Strong companies could very well get stronger, as the US growth market shows, and it is important to carry out a thorough analysis of the opportunities and risks each represents. Beyond that, both styles complement each other and we have plenty of cash to overweight value stocks if we see an opportunity. It will be the strength of the wind in the storm which will determine our position. In turbulent weather, mariners may choose to trim their main sail. As conditions improve, the main sail will be once more hoisted and head sails deployed to maximum advantage.

Clients of Nedbank Private Wealth can get in touch with their private banker directly to understand how goals-based investing can help, or call +44 (0)1624 645000 to speak to our client services team.

 

If you would like to find out more about how we can help clients manage their investments, please contact us on the same number as above, or complete a form using the links towards the end of the page.

Investments can go down, as well as up, to the extent that you might get back less than the total you originally invested. Exchange rate changes also impact the value of your investments. Past performance is no guide to future returns. Any individual investment or security mentioned may be included in clients’ portfolios. They are referred to for information only and are not intended as a recommendation, not least as they may not be suitable. You should always seek professional advice before making any investment decisions.

about the author

Rebecca Cretney

Rebecca Cretney

Rebecca joined Nedbank Private Wealth in May 2004 having moved to the Isle of Man from Barcelona to pursue a course in Business Studies with the Isle of Man Business School. Rebecca was appointed to the role of investment counsellor in March 2019 to focus exclusively on the company’s discretionary investment management services.

 

She works closely with our teams of private bankers to provide support in advising our clients with integrity, and to give additional technical investment expertise where more complex portfolio requirements exist.

 

Rebecca is a Chartered Fellow of the Chartered Institute for Securities & Investment and a Chartered Wealth Manager.

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