History is filled with great rivalries. When the Montagues and Capulets are around, firkins will be flung. If the Hatfields and McCoys run into each other, fussing and fighting commences. And if you put a value investor and a growth investor in the same room, they will talk trash about each other.
The reason: Value investors buy stocks that they consider cheap, relative to earnings or other measures. Growth investors believe that stock prices follow earnings, and look for companies rising earnings. Neither camp can really understand the other.
For the longest time, the value camp had the upper hand. By one measure — the Fama-French Large Value Premium, formulated by University of Chicago Booth School of Business professors Eugene Fama and Kenneth French — bargain-hunters have enjoyed a premium of one and a half to two percentage points over the broad market for long periods of time.
"There's a whole lot of fluctuation above and below that during shorter and intermediate time frames," said Jeffrey Ptak, global director of manager research at Morningstar.
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That premium has been scarcer than a Red Sox fan in Yankee Stadium in recent years — and, thanks to the massive rally in technology stocks, even long-term investors haven't gotten a boost from value. If we look at the past 30 years — certainly the long term by anyone's definition — large-company growth funds have gained an average 9.23% a year, while large-company value funds have gained 9.01% a year. In fact, growth has topped value the past 25, 20, 15, 10 and five years.
'Looking at price returns six months before, during and after bear markets and corrections since 1980, the S&P 500 Growth Group has recorded a greater frequency of beating the S&P 500 than has the Value group," Sam Stovall, chief investment strategist for U.S. equity strategy at CFRA, noted in a recent letter to clients. "The group's 10.6% compound annual growth rate since 1975 has made it a better long-term holding than the value group's 9.2% CAGR, provided you could have withstood the near 30% increase in volatility."
Well! Glad that's settled. Next up: Solving the Middle East situation.
Naturally, the question of growth versus value isn't quite that simple. First, What has happened to value? To some extent, value has become such a well-known investment factor that the payoff to tilting a portfolio towards value likely to be less going forward, Mr. Ptak said. Another reason is that value investors tend to be attracted to financial stocks — and, in many cases, bear markets involve a financial crisis. In the 2007 to 2008
bear market, for example, the average large growth fund fell 40.9%, while the average value fund fell 44.7%.
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But few people are saying it's time to send value investing to the Museum of Old Ideas, along with the Ptolemaic system and Green Stamps.
"We think value investing still has merit and a rotation to value using ETFs makes sense," said Todd Rosenbluth, senior director of mutual fund and ETF research at CFRA.
One reason, of course, is valuation. Amazon now sells for 228 times trailing earnings and 125 times estimated 12-month earnings. Netflix sells at similar levels. Currently, Standard & Poor's Growth Index sells at a 2018 PE of 19.8, while its Value Index sells for a more reasonable 14.6 times earnings. Another is that if one believes that markets tend to return to their long-term average gains, the most likely outcome is that growth will lose momentum and value will regain it. Value funds are also likely to have
buyout candidates in their portfolios, and many companies are flush with cash and eager to snap up other businesses.
If you're considering adding value funds to a client's portfolio, you have two main considerations. First, there's no widespread agreement as to what, exactly, constitutes a
value stock, Mr. Rosenbluth said. And that means that there can be wide differences between any two value funds or ETFs.
For example, the largest holding of the Vanguard Value ETF (VTV) is Microsoft, which sells for a remarkable 88.2 times its past 12 months' earnings and a more modest — but still pricy — 23.64 times future earnings. (The fund's second-largest holding is Berkshire Hathaway, run by the world's most famous bargain-hunter,
Warren Buffett.) The iShares Edge MSCI USA Value Factor ETF (VLUE) has Apple as its largest holding, which sells for a more reasonable 18.05 times trailing earnings.
Your second consideration: Preparing your client for sometimes prolonged periods of underperformance.
"You have to be very careful to set your client's expectations," Mr. Ptak said. Value funds will reduce a stock portfolio's overall volatility, but both you and your client will have endure periods when owning value feels like taking the losing side in a long-running argument.
