The dispersion between growth and value stocks is at its widest for decades. But this masks a number of nuances around how stocks are categorised, as Matthew Beesley explains.
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Here’s a headline that won’t surprise you: the gap between growth and value stocks is now at its highest since the dotcom boom.
Data from Empirical Research shows that there have only been two other occasions since 1926 when the relationship between growth and value has been so stretched: once in the early 1930s and then in 2008-9.
Some argue that the pandemic will exacerbate this gap. For example, earnings in the second quarter showed what we already knew: that tech companies have benefited from an acceleration in the adoption of home-based activities. At the same time, some companies that were already struggling to arrest structural pressures, such as physical retail, have seen their problems increase. Of course, the economic cycle will be yet another factor. But the historical relationship between the economy and growth or value stocks has changed.
Going beyond sectors
There are nuances within the value-growth labels. ’Defensive growth good, cyclical value bad’ is a refrain currently doing the rounds. This begins to identify some of the variances within ‘value’, which is generally perceived to perform well as the economic cycle improves. But from the perspective of an active manager, this is an over-simplification. Yes, a number of lowly-valued companies can be found in sectors which are more economically sensitive. But our managers can also find many companies offering reasonable or cheap valuations in more defensive parts of the market, such as telecoms or utilities.
It’s also worth looking at the changing anatomy of value stocks. In 2000, healthcare stocks were only 6% of the value index. Today, they have more than doubled. It is difficult to see immediately how pharmaceutical stocks with multiples in the mid-teens fit into today’s global value indices.
This leads to the important distinction of what a value investor does. The factor-driven description of value is defined by MSCI as price versus book value, cashflow and forward earnings. These are key inputs for any investor. But value investing entails a great deal more investigation to identify companies with attributes that are under-appreciated – and therefore undervalued.
Each potential holding is assessed on its inherent prospects: the company’s management and culture; its potential for growth versus its peers (easily overlooked if stocks are bucketed by the sector they’re in); the stability of cashflow in different economic environments; and many other qualitative inputs which come from face-to-face meetings and first-hand research.
Value or growth, or both?
Our fund managers have a range of different investment approaches from absolute return through thematic to growth at a reasonable price. None of them are pre-determined ‘value’ managers and none is given to dogma about growth versus value. Each team assesses each stock on its individual merits to build portfolios. Taken at face value, this may end up with what looks like a bias towards value – and a selection of our managers have built and had to defend notable positions in ‘value’ stocks. But for many of our managers and the funds that they manage, this will be transitory exposure to this style characteristic.