The stock market diverged again with the Dow Jones Industrial Average (INDU +0.59%) and S&P 500 Index (SPX -0.06%) outperforming the Nasdaq Composite Index (COMPQ -1.33%). Some blame the rise in interest rates for the S&P Value Index (SVX +0.99%) outperformance today against S&P Growth (SGX -1.00%). Others suggest that this is part of the re-opening trade favoring the cheaper, value-related sectors over the higher price growth sectors.
The merit between the two contrasting investment styles is akin to choosing Batman or Superman as the best superhero.
Although the two investment disciplines take different approaches, both styles are not suitable for all investors. A mix of growth and value stocks in your portfolio may help cushion an investment portfolio as the economy moves into its mid-cycle expansion/recovery phase and endure another potentially volatile mid-term election year.
The primary objective of investing in growth companies is to generate capital appreciation in stocks that grow faster than the market and peers. Growth companies are typically more expensive but offer higher upside potentials with higher risks. However, there is no guarantee the growth will sustain and translate to actual profits. Since growth stocks are more volatile, they may be more appropriate for investors willing to take higher risks. Nonetheless, investing in quality secular growth sectors and stocks will protect investors if rising inflation becomes an issue this year.
Value investors focus on finding undervalued stocks that trade below their intrinsic values. They seek out stocks trading at bargain prices at the earlier stage of intended stock recovery before other investors recognize their true values. Capital gains are not necessarily the sole objective of value investors. Value stocks are less expensive and offer fewer upside potentials (capital gains) but offer higher dividends and lower risks than growth stocks. Two reasons why professional investors may shift into value stocks this year – less perceived risk and lower beta. However, there are numerous value traps when the economy enters the mid-cycle expansion/recovery phase. Investors should always avoid secular lagging sectors and stocks unless they are very patient or have a longer-term horizon.
Value investing trend sustainable long-term?
The uncertainties surrounding the Omicron variant, rising inflation, Fed tapering and hikes, Mid-term Elections, trade wars, and geopolitical concerns weigh on investors. In the past two months, the rotation toward the re-opening, cyclical, and value-related stocks suggest investors are warming up to this investment style. Although the recent trend for value stocks is undeniably better than at any time in recent years, the question remains – is it finally time for value style investing to take over the mantle from growth style investing?
The topic remains controversial and debatable, partially because the growth versus value paradigm is subjective. There remains a lack of clarity of what constitutes a value stock versus a growth stock. Benjamin Graham, father of value investing, defines value stocks as securities currently out of favor with expectations that full valuation will occur later. Value stocks sometimes trade at discounts to their peers for a reason. Structural problems sometimes can lead to substantial discounts on the marketplace. Under this scenario, undervalued stocks may turn into value traps. They are cheap for a reason and deserve to trade at a discount over the long term.
The long-term structural trend for growth stocks has not changed, but…
The recent rotation into value stocks may not be necessarily about growth versus value investing. It may be the resetting of overvalued growth stocks and the repositioning into some of the re-opening names. It is also possible the once-a-decade pandemic may have accelerated the normal historical relationships between the growth versus value call. Nonetheless, the long-term structural trend for secular growth sectors and stocks has not changed. The pandemic may have changed investors' preferences for value versus growth stocks, at least on a near-to-medium-term basis. However, it remains too early to determine if this will lead to a structural trend change.
In the meantime, there is some value to diversifying investment portfolios across both investment styles to create a balanced portfolio heading into 2022.
After all, the price you pay for security still does matter. If you pay too much, it does not matter if it is a value or growth stock, if it is overvalued it will eventually trade toward its intrinsic value, over time. The popular call today is for value to outperform growth. However, that does not mean investors should make wholesale changes to their portfolios. Including both solid secular growth and quality value names in your portfolio will allow for balance. Most importantly, you can sleep at night and avoid the fear of missing out when one investment style dramatically outperforms the other.