Growth stocks have outperformed their value stocks counterparts for years. Then, after a brief stint at the top at the end of last year, the stock fell behind again.
Rest assured, value-driven investors: new research provides further evidence that value is a good bet to outperform growth in the years to come.
Value stocks, of course, are those that are not in favor, trading for relatively low price ratios to various measures of fundamental value, such as earnings, sales, and book value. Growth stocks, on the other hand, trade for relatively high ratios, in anticipation of their growth in those valuations.
Although the average value category over the past century has outperformed growth, it has lagged unusually over the past 15 years. Starting last fall, the value began to reaffirm its historic dominance. But after a strong streak of several months, it has started to slow down again in recent weeks. Many wonder if this means that the stock’s race is now over, or if the past few weeks are just a pause on the path to a sustained period of relative strong performance versus growth.
New research that points to this latter perspective comes from AQR Capital Management. In a webinar last week, AQR founder Cliff Asness questioned whether fundamentals could explain the much higher valuations investors currently place on growth rather than value. His short answer: “No.
To understand the significance of what AQR found, it’s helpful to remember that earnings from growth stocks should almost always grow more than those from value stocks. That’s what makes them growth stocks, after all. The question is how much more and at what price.
Focusing on price first, it’s worth noting that the recent wave of outperforming value growth has barely dented investor collective preference for growth stocks over value. Consider the average price / earnings ratio of growth stocks: According to Yardeni Research, the forward P / E ratio of the S&P 500 Growth Index is currently 11.7 points higher than that of the S&P 500 Value Index, or close to three times higher than the average differential of the past. decade. Asness, in an email, said that “AQR, using different methods and different definitions of value, finds similar lace price differentials.”
Then focusing on earnings, AQR research finds analysts’ earnings forecasts don’t show such a big difference between growth and value. Analysts predict that the five-year earnings per share growth rate of typical growth stocks, relative to value, is about the same today as the historical average. Specifically, Asness reports that from 1990 to 2017, the five-year projected EPS growth rates of growth stocks were on average 4.2 percentage points annualized higher than those of value stocks. As of June 30, this difference was 2.6 percentage points. (These averages were based on a weighted average of 2,000 global stocks.)
Point? Profit forecasts cannot explain why growth has historically been so expensive relative to value.
Of course, earnings growth is not the only indicator that can be used to differentiate growth and value. Some of these others look better for growth, and some worse. Overall, however, Asness found that they told a similar story to where his company simply focused on analysts’ earnings growth forecasts.
|Company / Teleprinter||Price / earnings ratio||Price / book ratio||Price / sale ratio||Number of newsletters currently recommending purchase|
|FedEx / FDX||14||2.9||0.9||4|
|Intel / INTC||11.9||2.6||3.1||4|
|Pfizer / PFE||11.1||3.0||3.2||4|
|Air lease / AL||10.7||0.7||2.2||3|
|Anthem / ANTM||15.4||2.6||0.7||3|
|Berkshire Hathaway / BRKB||24.3||1.3||2.2||3|
|CVS Health / CVS||10.7||1.5||0.4||3|
|JM Smucker / SJM||14.9||1.6||1.9||3|
|Leggett & Platt / LEG||17.8||4.3||1.3||3|
|Snap-On / SNA||16.6||2.9||3.0||3|
Note: Data as of July 20
Sources: Hulbert ratings; FactSet
It is in resolving this disconnect between fundamentals, which should remain consistent with the past, and the historically extreme price differential between value and growth stocks that Asness believes value is “much more compelling than value. growth”.
You might still be impressed by AQR’s conclusion that growth stocks’ EPS is expected to grow 2.6 percentage points annualized faster than value stocks, on average, over the next five years. But a higher rate of earnings growth does not necessarily translate into better stock price performance. This is because the return of a stock will be a function of its performance against expectations. A growth stock’s EPS may rise and yet its stock always drops if its rate of growth in its EPS is lower than what the market is currently expecting.
Imagine a horse race in which you are allowed to bet on one of 10 running horses. Suppose the overwhelming favorite finishes third, while the horse expected in a distant tenth finishes seventh. It is not excluded that you would win more money if you had bet on the seventh rather than on the one who came third, even if the horse was still much faster.
It should be emphasized that while Asness believes value will outperform growth in the years to come, he advises that your equity portfolio be diversified and exposed to other factors besides value, including quality and quality. momentum.
If you want to increase your exposure to value stocks, exchange traded funds are probably the most convenient and inexpensive way to do it. For large cap value stocks, one of the cheapest ETFs is the
Vanguard S&P 500 value
ETF (ticker: VOOV), with an expense ratio of 0.10%. For small and mid-cap value stocks, there is the
Vanguard Russell 2000 value
ETF (VTWV), with an expense ratio of 0.15%.
For ideas of individual value stocks, I pulled the Hulbert Financial Digest’s investment bulletin database for stocks that were highly recommended by top performers. Specifically, I started with all the stocks recommended by at least three of the top performing newsletters, then eliminated all of the stocks that didn’t have P / E ratio, price / book ratio, and price / sales ratio. were not inferior to those of the S&P 500..
The 10 stocks that survived this sorting process are listed above, in descending order of the number of buy recommendations each is currently receiving.
Mark Hulbert is a regular contributor to Barron’s. Its Hulbert Ratings tracks investment bulletins that pay a fixed fee to be audited. He can be contacted at [email protected]
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