Talking about investment styles almost always culminates in the age-old debate around growth or value, and which is the most profitable. Many analyses of investing approaches rest on the inherent duality – or perhaps dichotomy – between the two. Investment managers are often firm believers in one or the other and rarely a mix of both or somewhere in between. Jack Plotkin, a former investment banking strategist with Goldman Sachs, describes the differences between value and growth stocks and why one would choose one over the other.
Growth stocks are those that the investing public believes can outperform the market because of their potential for growth over a period of time. For that to happen, a company either has to have a product or a line of products that are expected to do well on the market, or it appears to be run better than their competitors. “It’s in the name,” says Plotkin. “Growth stocks are growing quickly, meaning the underlying companies are ramping up revenues, grabbing markets, innovating products. We see growth in rapidly evolving sectors, like cloud technology, digital entertainment, and biotech.”
Value stocks, on the other hand, are those that analysts feel have been undervalued by the market, being traded at the prices below their intrinsic worth based on fundamental ratios and benchmarks. Jack Plotkin, who worked at Goldman Sachs for nearly a decade, notes that those are usually larger, mature companies that either have a slow anticipated growth trajectory or have fallen out of favor. They may have reached critical mass or are part of a low growth industry. Still, value managers are ready to bet that the market has overestimated the severity of their setbacks and that they will bounce back. “Value stocks tend to be in sleepier industries, like utilities and consumer staples, and they tend to throw off a dividend,” says Plotkin. “Value stocks is what growth stocks typically turn into once their industry matures and settles down into more predictable financial patterns.”
Growth vs. Value; two sides of the same coin
Jack Plotkin notes that growth and value are two opposing poles of the investment world. Growth stocks generally have high price-to-earnings multiples because investors expect explosive growth moving forward and are willing to pay a premium for that anticipated growth. By contrast, value stocks have low price multiples that reflect their slower growth trajectories and that may be representative of an undervaluing by the broader market.
In addition, growth stocks are usually linked to higher volatility as they depend more on the overall health of the economy. “It’s like the tortoise and the hare,” says Plotkin. “The hare generates all that excitement, but the hare is unpredictable and therefore risky. That’s your growth stock. By contrast, the tortoise is slow and steady, it has done this a hundred times before and will do it a hundred times again. It’s not as fast, not as sexy, but it’s more of a sure thing. That’s a value stock.”
If an investor cares about stability, in terms of both appreciation and dividends, value stocks are a safer bet. By the same token, growth stocks provide the best opportunity to quickly realize a significant gain. “A growth stock can appreciate in six months as much as a value stock appreciates in six years,” says Plotkin. “But it can also lose more in six months than a value stock ever does. That’s your trade-off, in a nutshell.”
The performance difference
As far as comparative performance, growth stocks tend to do better during economic expansion while value stocks perform better during recessions. “Buy growth for the upside, value for the resilience,” says Plotkin. “Also consider your time horizon. Value does better over multiple decades, but growth can be a rocket over 5-year horizons if you time it well. But these are just rules of thumb. I can show you winners and losers in both value and growth over any time horizon.”
In recent times, growth has outperformed value. Over the first half of 2020, Morningstar U.S. Growth and U.S. Value indices have had contrasting returns, namely a 14.9% gain versus a 18.5% decline. This highlights a paradigm shift, whereby a pandemic-induced crisis upended conventional wisdom as growth stocks, powered by tech giants who had little or no issues with lockdowns, easily shook off the March losses. Value stocks, on the other hand, took a fall as many traditional industries sharply declined as a result of the virus. Even over longer terms, growth stocks have been doing better even over a longer term. One study, conducted over the last 25 years by UK-based Brewin Dolphin, has shown growth beating value by a 1,072 to 624 score in terms of percentage return.
“The problem with historical analyses is that they are not always the best predictor of future returns,” says Plotkin. “Growth has outperformed value over the last couple decades, in part because you had two massive bull markets and tech booms, first with the internet and then again with mobile. Moving forward we may well be staring into the teeth of a protracted downturn and value might do better than expected.”
Jack Plotkin and the bottom line
In general, investors tend to be drawn toward either value or growth. Some people like the risk and thrill of trying to pick the next star in an emerging industry while others prefer the certainty of steady growth and consistent dividends. “The most accomplished investors know how to pair growth and value strategies for a balanced portfolio and strong returns across the range of market conditions,” says Plotkin. “It’s the equivalent of being ambidextrous. Regardless of the volley the market sends your way, you can take it on either the backhand or the forehand.”