Warren Buffet, one of the most famous proponents of value investing, must be smiling right now. After underperforming growth stocks for almost a decade, value stocks have taken the lead.
Value stocks overtake growth
Since growth stocks had such a long run, it was hard to imagine value stocks being back in the spotlight. Especially when the gap in performance between the two significantly widened at the end of Q1 2020, around the same time the pandemic hit. The Financial Times reported that value stocks had their worst performance relative to growth that same year. However, the tide has begun to turn. As you can see from the graph below, value stocks have been outperforming growth since the beginning of the year:
Some analysts believe that this trend is here to stay for the coming years. But there are also many betting that this is just temporary and growth will once again be on top.
What is driving value stocks?
There are several theories analysts have pointed to for the recent outperformance of value stocks. One explanation some are pointing to is interest rates. The idea is that when interest rates are low, growth stocks benefit because money is cheaper, and investors are more likely to take more risk in hopes of a bigger pay-off. As we know, interest rates are rising, which favours value stocks over growth.
Inflation also plays a big part here. In general, growth stocks can be considered longer-duration assets with the expectation that there will be greater cash flows in the future. When inflation is high, this discounts these future cash flows. Value stocks, in contrast, have more stable near-term cash flows, giving them the advantage in this case.
Another factor related to inflation is pricing power. When prices are rising due to inflation, companies with actual earnings (value stocks) are likely to be better positioned to increase their own prices and retain profit margins.
A quick recap on growth and value stocks
If this jargon is new to you or you need a refresher, here are some of the main differences between growth and value stocks:
|Characteristics||Strong earnings growth potential, quick growth, younger companies||Steady income, slow growth, older more established companies|
|Valuation||High P/E ratios||Low P/E ratios|
|Sector examples||Tech, Consumer Discretionary, Communications||Financials, Energy, Healthcare, Industrials|
|Company examples||Tesla, Netflix, Amazon||Johnson & Johnson, Berkshire Hathaway, Proctor & Gamble|
|Dividends||Less often||More often|
Should I invest in growth or value stocks?
Choosing a growth or value investment strategy both offer benefits and drawbacks. It is important to make investment decisions based on your investment plan, considering factors like risk tolerance and investment horizon. Including a mix of growth and value stocks in your portfolio can help to diversify and spread risk.
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Sources: Bloomberg, Reuters, Investopedia, Visual Capitalist