The shifting values of growth and value
Kyle Tetting: Paige, despite a decade-long run for growth stocks, we’ve seen a resurgence of value as we look at the broad landscape of stocks. Of course, I think it’s important to understand that there’s a variety of reasons why value would be the thing that’s starting to lead again. Beyond just that the uncertainty that’s taken markets and the fact that value tends to be a little bit more stable, some other things that we’re looking at.
Paige Radke: Yes. So, one common way to distinguish between growth and value is to look at the different sectors that they lie in. On the growth side, you’re going to see more of what you would expect: Growth areas of the market. So, think information technology, consumer discretionary, as well as the communication services area of the market. Versus value – that’s traditionally going to be things like energy, materials, consumer staples, the industrial space, as well as financials. There are lots of factors at play here, but just with where we are in the current economic cycle, there are lots of things out there that are pushing up the value area of the market, despite what’s happening on an individual company basis.
Kyle: And I think it’s important that we understand what the difference between value and growth is because it influences that conversation.
Paige: Exactly. So, like I said, one way to distinguish is looking at the different sectors. That’s not always a tried-and-true way to do it. The other option is to look more at the characteristics of the companies.
So, on the value side, you’re going to have more established companies with stable cash flows, likely paying a dividend, where they’re not going to be trading at quite high of earnings multiples because you’re not expecting them to grow at the very high rates. So, you’re really paying for what you think they’re worth today.
You contrast that to the growth side of the market, which it’s just like it sounds: You have earnings growth, revenue growth. They’re less likely to pay a dividend, and they’re more likely to trade at higher earnings multiples. The idea behind that is if you think this company is going to continue to grow, you’re willing to pay a little bit more today for that expectation, and so therefore you see those higher prices.
Kyle: And of course, the challenge we face when we’re basing these decisions on expectations is that we’ve got to discount that future expectation down to some level that we think that should be worth paying for today. If interest rates are higher, we’ve got to discount by a larger number. It means growth stocks may be not quite as attractive as they used to be.
Paige: Exactly. And that’s one of the real issues at play right now. So, when you’re looking at a growth company, they tend to do the best when you have economic growth, when you have low inflation and when you have low interest rates. All of that contributed to the growth outperformance over the last decade. But now, we have a situation where we have rising interest rates, inflation is higher than it had been before, and we have some concerns about potential economic slowdown. So all of those conditions make it so that you’re not quite as willing to pay up for those future earnings because there’s more uncertainty around them.
Versus the value side of the market: You’re paying for what they’re worth today. There’s more certainty in those cash flows, and so again, when you’re looking at a situation like now, where we have shifting dynamics in the stock market, it’s all ripe for value to outperform.
Kyle: And I think that’s the critical point is understanding where we’ve been but also understanding where we’re headed. Of course, it’s never all or nothing. It’s never one or other. While there’s certainly plenty of opportunity in value, there are some reasons why you might want to have growth as part of your portfolio as well.
Paige: Of course. There is never going to be a point in time where we would recommend shifting your entire stock allocation from growth or value to the other. There’s always going to be a reason that you want to have a healthy allocation to both because we don’t know when the dynamics are going to change. We don’t know how long interest rates will be rising, and we don’t know how long they will stay high — much like we didn’t know how long they would stay low. It just happened to be for a long time. So that’s one piece of it.
The other part too is that not all stocks necessarily fall within one or the other. You’re going to have names out there that we like to call GARP funds, or GARP stocks, which means Growth At a Reasonable Price. So right now, they may still have higher valuation multiples. They still have some areas of their business that have high potential for growth. But then they also have some other areas with recurring revenue and more stable cash flows. And they may even be likely to pay a dividend. So there’s going to be growth names, value names and those that fall somewhere in between. And really, there’s a place in the portfolio for all of those.
Kyle: I think, Paige, it’s such an important thing to understand how this all fits together, to understand the way that some of our expectations for the future fit into the way we allocate portfolios. As you rightfully point out, it’s not just about this one thing or this other thing but understanding that everything has a place.
Paige: Yes. And again, looking back in time, traditionally we’re going to look and see that value has outperformed growth. Going back to 1936, that was the case in 85% of the time when you’re looking at a 10-year rolling basis. Almost all of the cases where growth outperformed value have been in the last decade.
So, we were coming off a time period where growth has had extraordinary outperformance relative to the value side, and that cannot last forever. And so really looking at both of them, having a piece of both, having the thing that’s going to grow, having the thing that’s going to be a little bit safer. And of course, looking at valuation multiples right now becomes increasingly important with the uncertainty.
Growth continues to be a little bit expensive relative to the 20-year average, versus value, which is still looking pretty cheap. So, if you can have some stable cash flows, businesses that are well established with pricing power and get them for a discount, that’s a dynamic that’s hard to ignore.
Paige Radke is an investment advisor at Landaas & Company.
Kyle Tetting is president of Landaas & Company.
Money Talk Video by Jason Scuglik
2022 Investment Outlook Seminar, a Money Talk Video
Value & Growth: Going Deeper, a Money Talk Videos with Brian Kilb and Marc Amateis
The outlook for value in your portfolio, a Money Talk Videos with Kyle Tetting
Get the total picture of your investments, a Money Talk Video with Paige Radke
(initially posted Nov. 23, 2022)
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