Value Investing versus Growth Investing
Similar to the small-cap versus large-cap debate, there will be times when value is in favor and times when growth is in favor. Also, like the small-cap-large-cap issue, investors should focus on the strategy that will lead to better results more often than not. No one gets it right all of the time.
There are no money-making machines. No one has a crystal ball. A portfolio manger once told me that if you get it right 60% of the time, you have done an excellent job. I completely agree with that sentiment. In a very general sense, being right 50% of the time would result in gross performance that is in line with the S&P 500 Index. According to Morningstar's data as of 3/31/2006, only about 27% of large cap blend funds have outperformed the S&P 500 over the past 10 years.
Also, similar to the large-cap versus small-cap debate, we must look to history as a guide to the future. The only reliable data that we have is historical. I am very skeptical about pundits or strategists or even analysts that try to project future returns. Even price targets that are based on fundamental information should be viewed somewhat skeptically when projected for short time periods.
Many reputable studies have shown that value has outperformed growth over long periods of time. According to the Ibbotson 2006 Yearbook, from 1968 through 2005, IA(Ibbotson Associates) Large Cap Value Stocks returned a geometric average of 10.8% while IA(Ibbotson Associates) Large Cap Growth Stocks returned a geometric average of 9.1%. There are also studies that have shown that the results of the strategies are not that different. I have not seen one of these studies recently. My guess is that the media is more interested in these studies after growth has experienced a long period of outperformance.
There will always be investors that prefer value investments over growth investments and vice versa. There are significant differences in these investment styles. Value managers typically look for companies with some or all of the following characteristics: low price to: earnings, book value, sales and, cash flow. There are many value metrics. Value managers also may look for high dividend yields, restructurings, bankruptcies, managerial changes and high insider ownership. Additionally, value managers tend to have substantial exposure to certain sectors while much less exposure to other sectors. For example, value managers typically have considerable exposure to financials and industrials and are usually under exposed to technology. Technology company valuations are usually too high for a value manager. Value managers may also dislike the less predictable earnings of a technology company.
Growth Managers tend to focus on earnings. They look for high rates of earnings growth, earnings surprises, earnings that exceed expectations and price momentum, to name a few qualities. Growth managers are often heavily exposed to the technology and health care sectors of the market while they usually have much less exposure to financials and industrials.
It is also interesting to compare the personalities of value investors and growth investors. Value people tend to be very cautious, skeptical, worried, frugal, pessimistic, intellectual, and often very contrary. Growth investors tend to be trusting, relaxed, happy, optimistic, confident, extravagant, and outgoing.
Despite the overwhelming historical evidence that value outperforms growth over time, investors still entrust plenty of their money to growth managers and stocks. For many people, it is very comforting to be invested in well-known companies with strong historical performance. If you are wrong about the investment, you will not be the only one losing money.