When it comes to stock investing, the age-old question remains: growth investing or value investing – which is better? In recent times, growth stocks like Apple and Nvidia have been outperforming value stocks. However, many investors believe that value investing will have its time to shine once again, despite waiting for quite a while.
Let’s take a look at what some top investing professionals have to say about growth and value investing, and when we might see value investing reclaim its position of outperformance.
Differences between growth investing and value investing
While some may view the distinction between growth and value investing as somewhat arbitrary, it’s important to understand the key differences between the two approaches, even if they may seem like stereotypes.
Growth investing
Growth investors seek out stocks that are currently valued at $100 but have the potential to reach $200 in the coming years if the company continues to grow rapidly. The success of their investment depends on the company’s expansion and the market’s willingness to assign a premium valuation to growth stocks, typically reflected in a high P/E ratio.
Growth stocks are often referred to as momentum stocks, as their rapid upward trajectory attracts more investors. Sometimes, this momentum is driven by investor expectations rather than the company’s fundamentals. If these expectations are not met in a timely manner, a growth stock may experience a decline before potentially rebounding.
Value investing
In contrast, value investors look for stocks that are currently priced at $50 but are actually worth $100 based on their current business operations. These investors typically target stocks that are undervalued and out of favor in the market, banking on a favorable shift in market sentiment that would drive up the stock price.
“Value investing is predicated on the idea that paying a lower price for a set of future cash flows leads to a higher expected return,” explains Wes Crill, senior investment director at Dimensional Fund Advisors. “This is one of the fundamental principles of investing.”
While renowned investors like Warren Buffett and Charlie Munger have been advocates of value investing, there are also wealthy individuals who favor growth stocks, such as Jeff Bezos and Bill Ackman. Even Buffett has adjusted his approach to incorporate more growth-oriented investments in recent times.
The differences between growth and value investing are further illustrated in the table below:
| Trait | Growth investing | Value investing |
|---|---|---|
| Company features | Rapid growth, innovative products, tech-focused | Steady growth or stagnation, traditional products |
| Valuation (P/E ratio) | Higher | Lower |
| Stock popularity | In favor, driven by momentum | Out of favor, overlooked |
| Dividends | Less common | More common |
| Stereotypical stock | Amazon, Apple, Nvidia | Procter & Gamble, Exxon Mobil, Johnson & Johnson |
| Volatility | Higher | Lower |
While the distinction between growth and value investing may sometimes appear artificial, there are instances where undervalued growth stocks and growing value stocks exist.
Ultimately, both growth and value investors aim to invest in stocks that will appreciate in value over time. Both value and growth companies tend to experience some level of expansion, making them attractive long-term investment opportunities. As such, the definitions of these terms can be fluid.
According to Blair Silverberg, CEO of Hum Capital, the traditional wisdom suggests that “when the markets are greedy, growth investors thrive, and when they are fearful, value investors succeed.” However, Silverberg notes that the current landscape, particularly in the 2020s, presents opportunities to find value in technology companies by investing in solid businesses at fair valuations.
Furthermore, the distinction between growth and value investing may be largely psychological. As Nathan Rex, chief investment officer at Eigenvector Capital, points out, the market sometimes overlooks the earnings growth potential of a company simply because it has been categorized as a value stock.
Which is better: Growth investing or value investing?
The superiority of one investing style over the other is contingent on various factors, as each style may perform better under different economic conditions. Growth stocks tend to excel in environments with low and stable interest rates, while value stocks may shine as interest rates rise. While growth stocks have dominated the market in recent years, value stocks boast a strong long-term track record.
Growth stocks continue to outperform
Over the past decade, growth stocks have enjoyed significant success, driven by large tech companies with promising growth prospects. Tech giants like Meta Platforms, Alphabet, Amazon, Apple, and Netflix, known as the FAANG stocks, have come to dominate the market. Microsoft, another trillion-dollar player, has also joined this elite group.
These tech-focused growth stocks, now referred to as the Magnificent 7, hold substantial weight in key indexes like the S&P 500 and Nasdaq-100.
According to Vanguard, U.S. growth stocks outperformed U.S. value stocks by an average of 7.8 percent per year over the ten years leading up to April 2023.
So, what factors have been propelling growth stocks during this period?
“Investors have become increasingly apprehensive about short-term events and a low-growth economy, leading them to pay a premium for future growth potential,” explains Rex.
Jeff Weniger, head of equity strategy at WisdomTree Investments, attributes the growth vs. value dynamic to the market’s quest for companies capable of driving earnings growth in a low-growth, disinflationary environment. He points to tech and communications services stocks as the winners on the growth side, contrasting them with energy and financial stocks that have struggled in this environment – two sectors typically found in value indexes. The COVID-19 pandemic exacerbated this discrepancy, favoring tech stocks while challenging traditional companies.
Low interest rates further enhance the appeal of growth companies, as they often prioritize reinvestment over current profitability. In a low-rate setting, investors may overlook the lack of immediate profits due to the low cost of borrowing.
Norm Conley, CEO and CIO at JAG Capital Management, highlights the adverse impact of low interest rates on traditional banks, particularly in the 2010s and early 2020s. A flat yield curve in a low-rate environment constrained their earnings potential, compounded by regulatory challenges post the Great Financial Crisis. Conley notes that many value indices heavily feature “old economy” companies with asset-intensive operations, a mismatch amidst rapid technological advancements.
Although the dynamics of growth vs. value investing shifted in 2023 and 2023 with the Federal Reserve raising interest rates to combat inflation, resulting in a brief stint of favor for value stocks, investors eventually reverted to favoring growth stocks in late 2023 and throughout 2023. Growth and tech stocks rebounded well into 2024, signaling a resurgence in their popularity.
Value investing tends to outperform over the long term
While growth stocks may prevail in the short term, value stocks have a historical edge in the long run, according to Dr. Robert Johnson, finance professor at Creighton University and co-author of “Strategic Value Investing.” Data compiled by Eugene Fama and Kenneth French shows that over rolling 15-year periods from 1927 to 2019, value stocks outperformed growth stocks 93% of the time.
However, the same research indicates that in annual periods, value stocks outperformed growth stocks only 62% of the time, highlighting the importance of a long-term perspective in assessing investment performance.
It’s crucial to differentiate between value stocks facing permanent challenges and those experiencing temporary setbacks or temporary market disfavor.
“Value investors run the risk of investing in stocks that are cheap for a reason and continue to underperform,” warns Conley. Value traps, stocks that appear undervalued but have underlying issues, pose a threat to value investors. Conversely, growth stocks also carry risks, as highly valued growth companies may struggle to maintain their rapid growth trajectory, leading to potential setbacks for investors.
“Both value and growth investors face the risk of investing at prices that may eventually prove to be too high,” adds Conley.
When might value begin outperforming growth again?
Many investors are eagerly anticipating the resurgence of value stocks over growth stocks. After a brief period of favor in 2023, value stocks have once again taken a back seat to growth stocks, gaining renewed popularity from late 2023 onwards. Several factors can influence the shift towards value investing becoming more favorable.
One key indicator to watch is inflation. Weniger suggests that value stocks benefit more from inflation than growth stocks. In 2023, inflation hit its highest level in 40 years, but has since receded to 2.9% as of the July 2024 report.
Traditional value sectors performed well as rising energy prices fueled inflation and raised expectations for higher interest rates. This development boosted energy and financial stocks in 2023, as investors anticipated increased profitability for these companies.
Bankrate surveys conducted in late 2023 through mid-2024 reflect shifting sentiments towards value and growth stocks based on interest rate movements and inflation expectations. Despite expectations for value stocks to outperform as interest rates rose, subsequent surveys indicated a shift towards growth stocks as inflation concerns eased and interest rates declined.
Long-term studies suggest that the market eventually re-evaluates and re-rates value stocks.
Crill emphasizes that value investing remains a reliable strategy for enhancing expected returns over time. The longer one remains invested, the higher the likelihood of value stocks outperforming, as historical trends indicate intermittent periods of value outperformance.
A market correction or bear market could also prompt a resurgence in value stocks. With lower price expectations already factored into value stocks, they may exhibit more resilience during market downturns compared to higher-valued growth stocks.
“Bull market leaders often become bear market laggards, and a market downturn could lead undervalued value stocks to outperform, similar to the dynamics observed from 2000 to 2002 when high-flying stocks faced a reality check,” notes Weniger.
Bottom line
The debate between growth and value investing will persist, but empirical evidence suggests that value stocks tend to outperform over time, despite growth stocks attracting more immediate attention. For investors considering individual stock purchases, adhering to fundamental investing principles or opting for a diversified index fund can mitigate risks associated with individual stock selection.
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