The Divergence of Value and Growth

Investors have heard a lot about the value and growth investment styles over the decades. These styles have elicited great debate about the “best” approach to selecting investments. There are merits to each style, and accordingly, they tend to rotate in and out of favor. As the chart below demonstrates, the value style has been out of favor in recent years.

With volatility returning to the market and as a dyed-in-the-wool value manager, we thought it would be interesting to dive into the difference between the two styles.

The basket of securities found in the Russell 3000 Value and the Russell 3000 Growth indices are strikingly different in sector composition.

Several items of interest jump out:

  • As go Technology and Financial Services, so go growth and value

  • Technology is 35% of the growth index vs. 9.5% of value

  • Financials Services is 22.8% of the value index vs. 8.5% of growth

  • Growth has become highly concentrated in a handful of sectors

  • Five of 11 sectors in the growth index account for roughly 90% of the index

  • Alternatively, there are five sectors in the growth index that each have less than 2% exposure (with utilities at 0%)

  • Growth has only 1% exposure to Energy while value has 10.5% (making it the third largest sector in the value index).

The characteristics of the underlying holdings also paint vastly different stories.

The takeaways from this table are equally apparent:

  • Growth has become highly concentrated in a number of individual stocks

  • Of 1,795 stocks in the growth index, the top 10 stocks account for 32% (vs. 19% for value)

  • Growth has been driven by very large stocks with high valuations

  • The average size of the company in the growth index is almost twice as large as the average size of company in the value benchmark (although both fall in the range of “large cap,” the average size of companies in the growth index is nearing the $100 billion “mega cap” range)

  • The valuations of the growth stocks appear very high on virtually every measure

So what does all of this tell us and why does it matter to you?

We have seen more normal levels of volatility return to the market and with it some sizable downward moves that have also been noticeably absent during this historic bull market run. While many investors have grown accustomed to the steady climb of the market, experienced investors remember that this is not how it typically moves. Declines and corrections are a normal course of business and in part healthy for the market.

We know it is impossible to time the market perfectly, which is why we believe the best recipe for risk management is a strong investment discipline. Our discipline is value. We continue to believe that the value style will come back into favor and are particularly encouraged by the characteristics that we are currently seeing in the various styles.

We share these striking differences in growth and value to illustrate that there may be some inherent risk baked into the growth style after years of outperformance, and value appears well positioned to better weather potentially rocky roads ahead as it has done historically (shown in the final graph below).

Source of Data for the Charts above: Monthly index values obtained from ©YCharts from 12/31/78-9/28/18. The charts are for illustrative purposes only and are not intended as investment advice. Past performance does not guarantee future results. Indices cannot be invested in directly. The Russell 3000 Value and Growth Indices are based on the Russell 3000 Index, which measures the performance of the 3,000 largest publicly held companies incorporated in America, as defined by total market capitalization. Stocks are ranked by Book to Price ratio and their forecast long-term growth mean according to the Institutional Brokers' Estimate System (IBES) and then separated into value and growth stocks.

Source of Data for the Tables above: Values are as of 10/22/18 and obtained from ©2018 Morningstar. All Rights Reserved. The information, data, analyses and opinions contained herein (1) include the confidential and proprietary information of Morningstar, (2) may include, or be derived from, account information provided by your financial advisor which cannot be verified by Morningstar, (3) may not be copied or redistributed,(4) do not constitute investment advice offered by Morningstar, (5)are provided solely for informational purposes and therefore are not an offer to buy or sell a security, and (6) are not warranted to be correct, complete or accurate. Except as otherwise required by law, Morningstar shall not be responsible for any trading decisions, damages or other losses resulting from, or related to, this information, data, analyses or opinions or their use. This report is supple-mental sales literature. If applicable it must be preceded or accompanied by a prospectus, or equivalent, and disclosure statement.