While the global pandemic has impacted many facets of everyday life, it remains too early to say with certainty which changes will endure and which will prove temporary. In equity markets, the strong outperformance of Growth stocks relative to Value stocks has led many investors to question if they should be focusing their efforts solely on Growth investing. For the reasons discussed below, we remain committed to constructing a “Core” equity portfolio consisting of both Growth and Value stocks.
Before diving into the numbers, the table below provides general characteristics a stock possesses when being categorized as either a “Growth stock” or a “Value stock”.
When examining historical performance trends, we have used the quarterly returns of the Russell 1000 Growth (“R1000G”) and the Russell 1000 Value (“R1000V”) indices.
Although Growth stocks had been outperforming Value stocks in recent years, the onset of the pandemic amplified Growth’s superior performance. The peak of Growth stock dominance occurred at the end of Q3 2020 as the return of the R1000G exceeded that of the R1000V by 43.6% for the prior 12 months, the largest such deviation in the history of the indices. Taking a longer-term view produces the same result. The annualized 5-year return differential between Growth and Value stocks achieved its historical peak of 13.6% at the end of Q3 2020.
With those numbers in mind, it is not difficult to understand investors questioning the viability of investing in Value stocks. Is something truly different this time? Have Value investors been passed by and their processes for selecting wealth building stocks become obsolete? Is the outperformance of Value stocks over Growth stocks by 5.9% for the 12 months ending 9/30/2021 an anomaly or the beginning of a larger trend?
We are no more clairvoyant than the next market prognosticator and maintain that it is too soon to declare the demise of Value stocks. Throughout the equity market’s history, investment trends have come and gone with varying levels of strength and persistence. With them, investors’ emphasis on the driver of investment success has shifted across various factors from the fundamental (business model, valuation, and dividend policy) to the vogueish (number of eyeballs and disruption).
To illustrate how impactful betting on the “right” or “wrong” side in the Growth vs. Value derby can be to an investor’s returns, consider the data in the table below.
After outperforming Value stocks by an annualized 12.4% for the 5 years ending 6/30/2000, would a Growth stock investor have changed stripes? If not, we see that limiting the investable universe to Growth stocks led to wealth destroying underperformance over the next 5 years. Conversely, how difficult must it have been for a Value stock investor to persevere long enough to enjoy the outperformance of the 5 years ending 6/30/2005? We believe most investors that lived through this period would be surprised to see that over the full 10 years, Value stocks outperformed by an annualized 3%. While we cannot predict the timing or strength of future Growth or Value cycles, we are certain that they will continue to trade off the leadership position.
Rather than attempt to predict the near-term, relative fortunes of Growth and Value stocks and realign portfolios accordingly, we remain committed to a “Core” portfolio. Our strategy does not limit its investable universe based on a stocks’ categorization of either Growth or Value. We identify and invest in stocks of companies with sustainable business models, high returns on invested capital and high-quality balance sheets. Whether they fall in the Growth or Value category, stocks with these qualities have consistently proven to be long-term compounders of wealth.