It’s often repeated investing wisdom that value stocks outperform growth stocks over the long run. Since 1926, value investing has returned 1,344,600%, according to Bank of America. During that same time growth investing returned just 626,600%. Case closed.
Not so fast. Recently growth investing has trounced value investing. Over the past decade the Russell 1000 Growth Index has returned 17% annually while the Russell 1000 Value Index has returned just 10%. Some see this as a fundamental change in the markets brought about by technology companies. Others remind us that the same argument was made just before the dotcom bubble burst in 2000.
Ultimately, what matters to investors is not the relative returns over the past decade or past century. What matters are the relative returns over an investor’s time horizon. On that basis, predicting a winner is impossible, suggesting that a blend of value and growth may be the best option. Let’s take a look at growth vs. value historical stock returns and what they mean for your portfolio.
Value vs. Growth Investing
Value investing seeks to invest in companies that are undervalued relative to the market. Valuation can be measured in multiple ways, including price-to-earnings and price-to-book. In contrast, growth investing aims to invest in companies that are rapidly growing revenue, earnings and cash flow. As a result, they often appear overvalued based on valuation metrics. Here’s how these two investment strategies have played out over time across companies with large and small market capitalizations.
Large Cap Value vs. Growth
Whether value or growth outperforms depends entirely on the time period examined. That’s particularly true with large cap companies. According to the Federal Reserve, $1,000 invested in large growth companies in June 1978 would have grown to over $30,000 at the end of 2007. During that same period, an identical investment in large value companies would have grown to nearly $40,000.
Extending the period of analysis to the present, however, yields very different results. As of November 2020, the growth investment would have grown to more than $128,000. The value investment would have reached just under $94,000. In both cases the time periods examined spanned decades. Yet the recent outperformance of growth stocks flipped the results.
Small Cap Value vs. Growth
The argument in favor of value investing is strongest with small cap companies. Since June 1978, a $1,000 investment in small growth companies grew to about $96,000 as of November 2020. A similar investment in small value companies outpaced this performance significantly, growing to about $150,000.
Even so, the case for small value companies is not clear for at least two reasons. First, much of the returns data, including from the Federal Reserve noted above, assumes a lump sum investment at the start of the analysis, with no additional contributions or withdrawals. When contributions or withdrawals are considered, the sequence of returns, or the order in which you earn returns, becomes important. Second, the time period considered is unlikely to match a specific investor’s actual investment horizon. When both of these issues are considered, the results can vary dramatically.
For example, let’s assume an investor starts with $10,000 in 1990. Each month they contribute an additional $100. Based on these assumptions, by October 2020 a portfolio invested in 100% small cap value stocks would have grown to about $466,000. The compound annual growth rate (CAGR) would total 13.27%. During that same period, an investment in small cap growth stocks would have grown to more than $503,000 with a CAGR of 13.55%.
While small cap value stocks may have outperformed growth since 1978, an investor beginning their career in 1990 would have had a very different experience. Thus, using different beginning and ending dates, even over decades, will lead to different results. Some results favor value stocks while others prefer growth stocks.
The changing tides of the value versus growth debate may cause some to chase performance. Because growth stocks have outperformed value stocks over more than a decade, some may be prompted to plow investments into more growth companies. It’s even caused some to question whether value investing is dead.
Chasing performance, however, can result in lower returns. In one study, Vanguard found that a buy-and-hold investment strategy outperformed chasing performance across all asset classes. The buy-and-hold strategy was particularly successful with small cap companies.
Of course, one could buy-and-hold small cap value stocks. As noted above, however, this approach may or may not lead to higher returns over a given investment period.
Furthermore, there is some evidence that the outperformance of growth stocks is nearing an end. One study by J.P. Morgan concluded that value stocks could outperform growth stocks in a recession or if inflation and interest rates rise.
While predicting when the next recession or rising rates will occur is unreliable, there is no doubt that they will occur. When they do, value stocks are likely to outperform growth stocks.
Because it’s impossible to know what will come, a blend of value and growth stocks may be the best long-term approach for buy-and-hold investors.
Mutual Funds vs. Stock Selection
The value versus growth debate often revolves around mutual fund and exchange-traded funds (ETF) investments. Much of the analysis, for example, is based on returns of relevant value and growth indexes. Investors in individual stocks, however, also confront the question of investing in value or growth stocks.
Fundamental investors often favor value stocks because many growth stocks are difficult to value based on fundamental analysis. For example, the J.P. Morgan study noted above found that over 70% of the companies with initial public offerings in 2019 had negative earnings. Without earnings, a company is difficult to value.
Many growth companies that do have earnings trade at extremely high multiples of those earnings. A fundamental investor is not likely to invest in a company that can’t be reasonably valued or that appears overvalued.
As with mutual funds, however, value investors have underperformed growth investors over the past decade. Famed value investor Warren Buffett is a prime example. The returns of Berkshire Hathaway have trailed many growth companies, such as Amazon and Google. While this doesn’t mean that growth investing is preferred, it does call into question the long-term viability of a strictly value investing approach.
Value investing has a tradition of outperforming growth investing over the long run. Indeed, over the past 100 years, value has significantly outperformed growth. Over shorter periods of time that are more relevant to investors, however, the case for value is less clear. Even over several decades, growth investing has outperformed value investing. From a practical standpoint, this may suggest that a blended approach to investing that includes both value and growth companies is best.