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valuestockguide.com/valueinvesting/value-versus-growth-investing
Research conducted by Ibbotson shows that value stocks have left growth stocks in their dust
over a 40 year period spanning 1968-2008. This finding holds true for small, mid and large cap
stocks.
Academics typically classify value stocks by sorting a list of stocks on various price multiples:
price-to-earnings, price-to-cash, price-to-book, etc. These multiples are used to identify stocks
with low prices relative to the aforementioned measures (value stocks). The stocks that have
higher relative prices are defined as “growth stocks”.
Fama and French (1992) examined the performance of value stocks versus growth stocks in
different markets across the globe and found that value stocks were the winner in twelve of
thirteen markets. The study spanned 20 years, from 1975 to 1995 and is an extremely
influential study in this area of research.
Bauman, Conover and Miller (1998) built on Fama and French’s research, further
corroborating the evidence. They found that value stocks outperformed growth stocks in in a
majority of 21 international markets over a 10-year period.
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Capaul, Rowley and Sharpe (1993) found that value stocks selected using price-to-book ratios
outperformed growth stocks in France, Germany, Japan and the UK between the years of
1981-92.
Not to belabor the point but a 90 year study from Bank of America in conjunction with Merrill
Lynch found that value stocks generated an average return of 16.7% annually. Growth stocks
did well, but could not match their value stock counterparts (12.4%).
All this to say, the outperformance of value stocks is a phenomenon that exists not just in US
markets, but all over the world, and the finding holds across different time periods and
methodologies.
There is one caveat: the BoA/ML study did find that growth stocks tended to outperform value
stocks when the economy was contracting. Over the very long run however, you are better off
with a value-based approach, with value stocks beating growth stocks in 3 out of every 5
years.
It’s easy to see why growth stocks underperform when defining them this way, and reversion
to the mean plays a big part. Essentially many of these studies define growth stocks as having
high P/E ratios (or another single multiple, or a combination of a few different ones) and value
stocks as having low P/E ratios then performance is negatively impacted by the group of
growth stocks who move from high P/E groups to a lower P/E group over time.
In fact the effect is so pronounced, that if you were able to identify these stocks ahead of time
and exclude them, then growth stocks could conceivably outperform value stocks. That’s
exactly what George Athanassakos, Professor of Finance at Ivey Business School, found in
his study of the Canadian market from 1986-2014.
There’s a reason value investing is such a powerful strategy. By buying stocks at a discount to
intrinsic value, an investor is able to protect their downside and build in a margin of safety.
Margin of safety simply refers to the difference between the share price and intrinsic price per
share. If you think about it, there’s a lot less risk in buying a million dollar company for
$500,000 than for $2 million. Pair this pricing advantage with strong future earnings growth
then you put yourself in a great position to take advantage of asymmetrical returns.
What people really consider growth investing is more like momentum investing: trying to ride
the coattails of stocks that have shown strong growth in the past and are expected to continue
growing in the future. Investing in this manner is basically equivalent to speculation.
At the end of the day intelligent investing is value investing, and screening for consistently
strong earnings should be on any value investor’s checklist, and stocks selected using value
investing principles can serve as the growth component of your overall portfolio. There’s no
need to differentiate between two categories of stocks, instead expand your understanding of
what constitutes intrinsic value.
Further Reading
https://faculty.fuqua.duke.edu/~charvey/Teaching/IntesaBci_2001/FF_Value_versus.pdf
https://www.ivey.uwo.ca/cmsmedia/3775505/growth_versus_value_and_large-
cap_versus_small-cap_stocks_in_international_markets.pdf
http://www.merrilledge.com/Publish/Content/application/pdf/GWMOL/GlobalStrategyApictureguid
etofinancialmarketssince1800.pdf
https://www.ivey.uwo.ca/cmsmedia/3775496/value_vs_growth_stock_returns_and_the_value_pr
emium.pdf
Jiva Kalan is a writer whose work has been featured on DailyFinance, the Wall Street Survivor,
Plousio and Financial Choice.
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