The Age-Old Debate of
Growth vs. Value 

If the professionals can't figure it out, what's the average investor supposed to do - a peek into an ongoing debate in investment management.

John Schloegel

Growth and value are two fundamental approaches to stock market investing.  Growth investors seek to own stocks delivering strong earnings and sales momentum, while value investors look for stocks "undervalued" by the market place according to a variety of metrics.  Many growth managers believe their approach is superior, while just as many value managers believe their approach is most appropriate.  This makes it very difficult to choose which approach to adhere to!

How to Identify Growth vs. Value Stocks

Growth companies tend to achieve high earnings growth rates no matter what the economic environment.  Value stocks are those that have generally fallen out of favor in the market place, and are considered bargain basement priced compared to others when looking at book value.  Value stocks are priced much lower than other stocks of similar companies in the same sector, and their price is reflective of company problems, disappointing earnings, negative events, or any host of items that cause its stock to be "out of favor" by the marketplace. 

Primary measures of growth vs. value stocks are price-to-earnings ratios, price-to-book ratios, and dividend rates.  Growth stocks have high price-to-earnings and price-to-book ratios, at the same time as low or non-existent dividend payout ratios.  Value stocks usually pay high dividends, and have low price-to-earnings and price-to-book ratios. 

Growth stock managers buy high-quality, fast growth companies that have expectations for continued strong performance.  Investors will pay high prices for these stocks (high price-earnings ratios) with an expectation of selling them at even higher prices as the companies continue to grow.  The risk is buying a highly valued stock that can fall suddenly on any negative company specific news, particularly if its earnings fall short of estimates.

Value managers buy stocks of companies that have fallen out of favor but still appear to have good fundamentals.  These stocks usually trade below their historic levels or below the current valuation of other stocks in the same industry. 

Which Strategy is Better?

There is not a clear-cut advantage with one over the other.  The battle has been going on for years, with each side claiming victory every now and then.  The chart above depicts the most recent ten-year period and the differences between value and growth, sorted by size.  Suffice to say, since the value vs. growth debate will always be with us, we think it makes sense to have exposure to each category.