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How do we differentiate between growth and value? Can a company/stock be both? Or are those labels misused..?
The Veteran's digging into this and where better to start than... a song by The Carpenters? 😕
As the late great Karen Carpenter sang:
“So much of life ahead... We'll find a place where there's room to grow”
Although these lyrics were about love and relationships, they could also be used to describe the aspirations of many stock market investors and traders.
For example, she also sings
“So many roads to choose....We'll start out walkin' and learn to run (And yes, we've just begun)... Sharing horizons that are new to us ... Watchin' the signs along the way... Talkin' it over, just the two of us... Workin' together day to day”.
Sounds just like Macrodesiac to me!
It's a beautiful harmonious song with a tragic backstory.
Putting that to one side for now, I‘d like to focus on the room to grow, the idea of growth investing and growth as a factor.
We recently looked at the performance of equal-weight portfolios and indices and their performance compared to their cap-weighted peers. I want to do something similar in this piece.
So let's start by defining what we mean when we talk about growth in the context of investing and equity factors. No easy task in itself, because there isn't a strict one size fits all definition that everyone adheres to.
Indexation specialists MSCI define growth as follows:
“Growth stocks can be defined as companies that are expected to grow sales, earnings or margins above average compared to their industry or the market. The growth factor can benefit a multi-factor portfolio by reducing short-term cyclicality offering asset managers diversification and a persistent source of premia”
Just to be clear, when we talk about factors we mean idiosyncratic or specific characteristics that stocks and groups of stocks exhibit. Those features that contribute to, or define, a proportion of their returns versus their peers and the wider market.
Basically, all that stuff that differentiates them from the crowd.
Factor investing strategies seek to identify and isolate these characteristics either to create portfolios that outperform, or to allow for tactical asset/capital allocation in any given market conditions/environment.
Growth is perhaps one of the best-known and certainly one of the most celebrated of these factors or styles, and it is often compared to its great rival value.
Which is exactly what I have done here 👇
The chart shows the Invesco S&P 500 Pure Growth ETF (RPG) compared to its rival and stablemate Invesco S&P 500 Pure Value ETF (RPV) drawn in green.
The chart plots the relative percentage price changes over one year. Over this time scale value outperformed growth by almost 18.50%.
Over three years that differential slips down to just over 12.75% and over 5 years we find that growth outperformed value by just under 10%.
Research by Nicolas Rabener, founder of the research house Finomial, and something of a factor geek, tells us that there are around 40 growth-oriented ETFs. Most of these, like RPG, had not only underperformed value funds but also the wider stock market over the last year.
Rabener points out that,even though the concept of growth investing is well entrenched in the market, with growth-oriented ETFs managing just over $300 billion of assets, both 'growth' and other 'unverified' factors should not exist if we have a perfectly efficient market.
These factors should have been priced in and any advantage they offer should have been arbitraged away. What’s more, most academics believe that growth stocks are intrinsically expensive and therefore over time they should have negative returns.
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One could argue that this is borne out by data on the life cycle of stocks, such as that collected by JPM Asset Management in their Agony and Ecstasy note.
The analysts examined the life cycle and performance of the Russell 3000 constituents between 1986 and 2013 where growth sectors such as information technology had high rates of attrition.
While recent experience tells us that growth stocks can and do produce spectacular gains, those leaps come about when investors “get carried away by simply extrapolating the growth (potential) and driving valuations to excessive levels.”
We can see evidence for that here, in a chart from Finomial, as well as the effects, that cap weighting can have on returns (which we explored last week.).
With all of the above in mind, I would like to propose that growth and value are not disparate factors but rather that they are characteristics that stocks exhibit at different points in their lifecycles, and furthermore, that investors treat stocks differently at those points in time.
We could visualise stocks following a curve over time swinging from growth phases above the line and then as their business and market matures swinging back towards a value classification as they move below the line.
Perhaps they swing back to growth again as they adopt new technology and or enter a new area of business. Sometimes, conditions simply change.
2022 offered the perfect example when energy stocks, so often considered 'value', were exhibiting many of the characteristics typically associated with growth companies.
IBM went through something similar went it pioneered the desktop and personal computer market in the 1980s, having previously been focused on mainframe computers for business, academia and government.
Is it so much of a stretch to imagine Alphabet (GOOG) as a sort of modern GE; a giant conglomerate with fingers in many pies and many lines of business.
GE was in that position in the 1990s and has been trying to right size and rationalise itself over much of my stock market career. Only now after 30 years is that task nearing completion.
If growth stocks are successful then they take on the characteristics of mature successful businesses and their growth rates inevitably slow as they do so.
Warren Buffet hasn't bought Apple because it's a 'growth' stock, but because it's an established business with an economic moat and pricing power, which means it has room to grow. In Apple's case, that’s likely to be through new products and a move into services and subscriptions.
Other stocks are trying to re-invent themselves by hitching their wagons to the new and largely unproven technologies of quantum computing and artificial intelligence which may in time usher in new periods of growth and potentially create whole new industries and business sectors.
Google's not off to the best start... 👇