Which is better: growth or value? It’s an age-old investor question. Tony DeSpirito discusses its modern-day implications in a world of widespread disruption.
Full disclosure: I’m a long-time value investor. It’s a discipline I’ve always found to be rewarding even if it hasn’t always been easy. Recent history illuminates the struggle: The Russell 1000 Value Index has lagged its growth counterpart by roughly 4% annually over the 10 years ended Jan. 30, 2020.
The long-term win, however, still goes to value. Over the past 50 years, large-cap value stocks have returned 13.5% annually versus 10.2% for large-cap growth stocks, according to data from professor Kenneth French.
With a relatively strong macroeconomic backdrop and unprecedented disruption across industries, it would be reasonable to infer that the ongoing growth advantage could continue in 2020 and beyond. Successful disruptors are fruitful growers ― and the degree of disruption is only increasing. As shown in the chart below, variations of the word “disrupt” appeared in broker reports for 72% of companies we reviewed at the end of 2019, up from 39% at the start of 2002.
While we expect these trends to continue, we believe focusing exclusively on growth would mean missing out on significant opportunity on the value side of the ledger. We see great potential in both investing styles.
Going for the growth
Massive disruption, whether driven by technology, demographics or otherwise, is testing (sometimes displacing) traditional business models.
The rise of new and disruptive businesses has been a tailwind for growth investors, propelling the Russell 1000 Growth Index 16% annually over the past 10 years. Some worry that valuations are overextended, but we see few red flags. While many of these companies may appear expensive, their ability to compound earnings at an above-market rate suggests they could become relatively more attractive in 12-18 months.
Additionally, valuations for the broad group are not as high as they were at the peak of the dot.com bubble, and on a cash flow basis are not universally stretched. Interest rates are also far lower today, making stock valuations attractive relative to bonds. And importantly, most growth businesses today are exhibiting strong free cash flow, giving them the operational flexibility to absorb shocks.