Growth Stocks vs. Value Stocks

bear-market--My Comments: If you believe, as I do, that some of your money needs to be working harder than, say a Certificate of Deposit, then your likely solution is some kind of mutual fund or brokerage account. Most of us are not sufficiently sophisticated financially to explore other options, so for new, let’s assume you decide to own a stock portfolio of some kind.

One point on the decision tree is to choose between growth stocks and value stocks. If I’ve now confused you to the point of paralysis, then read the rest of this and see if it makes any sense.

by Sean Williams June 19, 2016

You can make a solid argument that the stock market is the greatest creator of wealth over the long term.

We’ve definitely witnessed a surge in home values since the 1990s, but the previous 100 years (1890-1990) saw home prices outpace the inflation rate by a paltry 0.21% per year, based on estimates from Robert Schiller via Irrational Exuberance. By comparison, inclusive of dividend reinvestment, the stock market tends to rise by about 7% per year, which is roughly double the rate of inflation between 1914 and 2014. Investing in the stock market arguably gives Americans their best chance of reaching their retirement goal and leaving the workforce at a time of their choosing.

The age-old debate: growth stocks vs. value stocks

However, the path by which an investor gets from Point A to Point B in the stock market has long been up for debate. There are easily more than a half-dozen investing strategies to choose from, but few get more credence than growth investing and value investing.

Growth investors are typically seeking companies that offer a superior growth rate relative to the overall stock market and perhaps their peers. Companies that are growing faster are often trendsetters, and presumably they should be able to keep up their superior growth for a long time to come. Companies with a high growth rate also have the potential to see their stock prices soar. The downside, as you might imagine, is that growth stocks aren’t always making money, and the valuations of growth stocks can be prone to getting ahead of themselves because of emotional investing.

By comparison, value investors are seeking investments trading at a discount to the overall market or a sector in question. Value stocks usually have mature business models that seek to maintain strong pricing power, modest growth, and typically reward long-term shareholders with a dividend or stock repurchases. On the downside, value stocks can always get cheaper, because trying to time a low is a fruitless practice. Additionally, since value stocks usually have mature business, they don’t offer the same eye-popping returns that can occasionally be seen with growth stocks.

“So which method is best over the long haul?” you wonder? That’s exactly what Bank of America/Merrill Lynch sought to find out.

Based on the study findings from Bank of America/Merrill Lynch over a 90-year period, growth stocks returned an average of 12.6% annually since 1926. However, value stocks generated an average return of 17% per year over the same timeframe. Said Bank of America/Merrill Lynch chief investment strategist Michael Hartnett, “Value has outperformed Growth in roughly three out of every five years over this period.”

Perhaps more interesting is that value stocks have tended to outperform during periods of economic growth, while growth stocks have proved better when the economic weakens or contracts. This would certainly help to explain why value stocks have left growth stocks in the dust, since the economy is expanding for a much longer period of time than it’s contracting or stagnating.

Also worth noting is that we’ve seen a bit of a reversal to this trend since the end of the Great Recession. In other words, growth stocks have substantially outperformed value stocks despite the U.S. economy returning to growth. However, we’ve also witnessed historically low lending rates during this seven-year period, which has made access to capital cheaper than ever for growth stocks looking to hire, expand, and acquire competitors. As lending rates normalize in the years ahead, we’re liable to see this divergence from the historic trend wane.

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