Growth or Value at All Cost?

The Russell 1000 Growth Index, a basket of US growth stocks, was down 5.6% in September. In comparison, the Russell 1000 Value Index, a basket of US value stocks, was down 3.4%

• Meaning… For the first month in 2020, value stocks finally outperformed growth stocks.

A quick lesson on growth and value stocks

Growth stocks are shares of companies anticipated to have a higher growth rate. These companies are often not making a profit and do not pay out dividends as they reinvest their money back into their business. E.g. Tesla ($TSLA), Netflix ($NFLX), Amazon ($AMZN).

While value stocks are companies that are considered undervalued by valuation metrics (e.g. price-to-earnings, price-to-book ratios). These companies are characterized by having lower growth and/or paying out a dividend. E.g. Bank of America ($BAC), McDonald’s ($MCD), Coca-Cola ($KO).

Who would win in a fight? Value or growth?

If one were to invest $1 each in value and growth indexes in December 1927, your investment in value stocks would be 18x larger. The tides changed in favor of growth stocks in 2006 with the rise of technology companies. Since 2006, growth returns have exceeded value returns.

2020 likely won’t be any different. Value stocks may have beaten growth in Sept. but growth is still beating value for most of 2020. With 3 months left in the year, value stocks have a lot of catching up to do. Why are growth stocks doing so well? Primarily, differences between the composition of the two types:

• Carry… Tech stocks, which make up a large portion of growth stocks, were the best performing sector in 2020.
• Deadweight… Financial stocks, which make up a large portion of value stocks, were the worst-performing sector in 2020.

For investors… The 2008 recession was the last time value stocks were trading at this much of a discount compared to growth stocks – value stocks outperformed growth stocks in the following 12 months. History doesn’t always repeat itself but here’s why market strategists believe value outperformed in Sept. 2020 and could continue beating growth in the coming months:

• Flight to safety… Investors prefer to hold less volatile, value stocks during uncertain and riskier market environments… Catchup: Why we’re likely to see higher volatility in the coming months.
• Finding discounts… Investors are moving away from overpriced growth stocks to buy cheaper value stocks.

Those heavily invested in growth stocks should consider diversifying into value stocks to ride out the potential volatility over the next couple of months. Christopher Harvey, equity strategist at Wells Fargo Securities, is favoring these sectors with “attractive valuations”, e.g. industrials, financial services, consumer discretionary, and real estate investment trusts.