It’s a longstanding debate in the investment world: Are growth stocks or value stocks the better investment?
Sounds exciting, right? It might come as a surprise then that you do likely have an opinion.
This topic comes up in our conversations frequently now thanks to the continued surge in tech stock prices. In a way, it’s the same question as the more academic debate, but now it’s personal. Why would I invest in anything other than [insert preferred superstar technology company]?
So what should you do? Read on for a small amount of historical context, a recap on why this conversation now, and our general approach to tackling these types of investment issues.
What are Growth and Value?
First things first. Let’s define the two categories. Per Investopedia:
Growth Stocks: A growth stock is any share in a company that is anticipated to grow at a rate significantly above the average growth for the market. These stocks generally do not pay dividends
Value Stock: Value stocks tend to trade at a lower price relative to their fundamentals, such as dividends, earnings, and sales, making them appealing to investors with longer time horizons.
How are these categories are represented in real life?
The following graph, from JPM Asset Management, shows value versus growth by sector as represented by the Russell 1000 Growth and Value indices; positive numbers translate to value oriented sectors, negative numbers show growth sectors:
If you’ve followed the market recently you probably recognize the issue. Info Technology as a category includes some rather well known companies – think Amazon, Apple, and others.
How has this translated into returns in 2020? So far, through 10/20/20, it has not gone well for value. The graph below shows year-to-date returns. Those Consumer Discretionary and Info Tech categories so heavily represented in the growth sector shoot to the top. Energy and Financials, value stalwarts, drop to the bottom. It’s a visually pleasing juxtaposition, as long as you’re not heavily invested in the wrong red bars.
This is encouraging so far for growth-focused investors. Stepping back to look at historical returns doesn’t deny the recent growth outperformance, but it does add context.
What we see here is the difference in annualized total returns between the Russell 1000 Value Index and the Russell 1000 Growth Index over rolling five-year periods. Unfortunately for value investors, the market has been on a 10+ year run of growth stocks consistently outperforming their value counterparts.
If you look back beyond 2009 you start to see where complications arise with the “all growth, all the time” investment philosophy. While growth had an excellent run at the end of the 1990s/early 2000s, value stocks spent close to ten years outperforming growth following the dot-com implosion of 2000. (Note, I’m labeling an inflection point, not implying a correlation.)
If we pull back further, we see roughly 50 years of mid-century value dominance. If you’ve wondered, this does help explain why many of the investment “Greats” were prophets of value-investing (Benjamin Graham and Warren Buffet, for example).
Making Sense of the Lines
Is all of this to say that what we are seeing now is merely an aberration and value is poised to come roaring back? No, not necessarily. Is everything different this time? Possibly. But history provides ample reason for caution when the conversation shifts to claims that everything is different “this” time. Personally, I feel comfortable with the assumption that there will be an eventual shift in favor of value-oriented stocks. The caveat being no one has any idea of when.
Commitment to any one type of stock – whether it’s a single company, a single sector, or a single country – is an inherently risky strategy. A great value investor who ignored the rise of growth-focused technology stocks is unhappy after missing the tech-fueled boom. Growth investors who banked on the dot-com era lasting forever got a rude shock when the bubble burst. And for those who “got it right,” remember that it’s not just the entry that matters, you have to stick the landing. Betting on a stock requires you to beat the odds twice.
Tech stocks driving returns
This brings us to the underlying conversation about growth stocks right now. In an analysis from mid-October by Reuters, we can see what is likely drawing in investors. Technology stocks.
Perhaps unsurprisingly, for many of our clients the conversation is not an academic growth versus value debate. It is technology sector versus everything else. In some regards, it’s an Apple/Microsoft/Google/Facebook/Amazon instead of anything else conversation.
The history of the ebb and flows between growth and value has a lesson. As do cautionary tales from previous titans of industry like Sears, Kodak, and Blockbuster. There is certainly money to be made, but getting caught with your, forgive the mixed metaphors, eggs all in one basket when the pendulum swings back can be extremely uncomfortable.
Diversification, but done thoughtfully
Where does this leave an investor? My answer is an attempt at realism: Thoughtfully diversified, concentrated on the side.
An appeal to diversification isn’t a surprise, so I’ll just sketch it out briefly.
A diversified portfolio smooths out the bumps of the market and allows an investor to capture market returns while maintaining control over the amount of risk to which they are exposed. These are our primary objectives: control for risk, capture returns.
What do I mean by concentrated on the side?
As a planner, I look at personal finances from a risk/reward standpoint. My clients’ goals vary: most want to retire at a certain age with a certain level of spending, many want to travel, send kids to college, purchase a home, etc. These are concrete goals that in many cases are non-negotiable. Extra portfolio returns are great, but not if the pursuit puts the primary goals in jeopardy. The risk is too high to justify the potential reward.
The funds for those core goals live in a diversified portfolio. We keep fees low, we rebalance as necessary, and we stay invested.
If there is extra money after those goals are covered? These are the funds that can be as concentrated as they want. In a way, it is entertainment money. If it evaporated tomorrow that would be disappointing, but it would not impact the overall plan.
This workable approach provides both security and the potential to engage in educated speculation – and let us call it what it is, speculation, not investing. It is particularly applicable at the moment for those working in the technology sector who are evangelists for their company or for a friend who is raising funds for a new project. You can be all-in from a career standpoint, but know when to take some risk off of the table.
Where does this leave us? The answer to the opening question is that yes, there is a place for non-growth/non-tech stocks in a portfolio. A lot can happen in 20, 40, or 60 years and calling a winner now seems preemptive. If a series of concentrated side bets is what gives you the peace of mind to keep your overall portfolio diversified – and have the potential to reap massive rewards – that’s fine. If nothing else, you will get some entertainment while protecting your long term goals. It’s your money after all, you should get to enjoy it as you see fit!