Investment professionals often simplify matters to define investment styles in relation to equities by classifying them into either value or growth stocks.
The underlying dynamics of value stocks mostly relate to companies that are deemed to be relatively cheap within sectors that are inherently biased towards stable business models. As the name implies, the word ‘value’ derives from the fact that investors will be buying a relatively cheap investment, however, this argument has a major flaw. Oftentimes, there is a valid reason for a company to have a comparatively low valuation.
Value companies and/or value sectors tend to experience low growth number in both sales and earnings, operate in mature markets and have business models that makes it difficult to significantly grow. As a consequence, investors shun these sectors and/or companies in favour of other exciting prospects in a period where market risk is low given the perceived benign business environment.
On the contrary, as market risk rises, companies that operate in stable industries will be the investment of choice for investors. As a result, market-based multiples such as the price-to-earnings ratio for value stocks are often lower than growth companies. Likewise, companies operating in stable business models tend to distribute most of their yearly earnings given that capital reinvestment will not be necessary to fund their low growth ambition.
A sector that is typically considered a value sector is utilities with the largest European utility company being Enel Spa, the Italian giant electricity and gas distributor that is valued at €68bn having a current dividend yield in excess of four per cent and a P/E multiple of 26x. Invariably, growth stocks are often characterised by companies which can be referred to as ‘stars’.
The tech sector is the prime example of a growth sector with the largest European information technology company, being SAP SE which is valued at €150bn, having a current dividend yield of 1.2 per cent and a P/E multiple of 43x. Company stocks that are deemed to be growth stocks often exhibit strong top and bottom line growth, operate in sectors that can produce new growth opportunities and retain most of the generated earnings in order to reinvest it in expansionary ventures.
Equity indices that track both of these styles show that in the European region on a year to date basis, growth stocks have outperformed value stocks by circa 14 per cent. The same could be said for the US region as US growth stocks have outperformed US value stocks by circa 11 per cent. A succinct look at market risk for the year shows that it has been mostly low which naturally favours growth stocks and explains the outperformance.
The crux of the matter centres on last year’s heightened market risk as a sample for abrupt market down moves. The resilience on US growth stocks saw this style outperform significantly US value (circa -11 per cent) peers as well as both European value (circa -9.1 per cent) and growth stocks by a significant margin. US growth stocks fell ‘just’ circa 2.3 per cent compared to European growth which fell circa nine per cent. In taking the long view, the post-crisis era has played handsomely to investors that tilted towards the growth oriented segment of the market, in particular within the US.
Since the end of December 2008 till the time of writing, a clear winner emerges as the generic S&P 500 index posted a total return of circa 330 per cent whilst growth stocks returned circa 415 per cent in total. Finally, over the period, historical volatility were similar for both indices which gives further credence to the investment style on a risk-adjusted basis.
Disclaimer: This article was issued by Jesmar Halliday, investment manager at Calamatta Cuschieri. For more information visit www.cc.com.mt. The information, view and opinions provided in this article are being provided solely for educational and informational purposes and should not be construed as investment advice, advice concerning particular investments or investment decisions, or tax or legal advice.