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Growth Stocks vs. Value Stocks

Do you buy a 'company of the future' like Tesla was 10 years ago, or a 'cheap-looking company' that already makes money steadily? This very question is the fork between growth and value stocks.

Definitions of growth and value stocks

A growth stock is stock in a company whose revenue and profits are expected to grow rapidly. Because value is placed on future growth rather than current profits, valuation metrics like the P/E and P/B ratios tend to be high. Dividends are small or nonexistent, and the money earned is reinvested back into the business.

A value stock is stock considered to be trading at a price low relative to the company's actual value. Many are mature companies with stable profits that pay dividends, and P/E and P/B ratios tend to be low.

In a word, growth stocks are closer to 'buying the future,' and value stocks to 'buying cheap.'

What history shows: value's long-term edge

Looking at long-term data from academia and asset managers, many analyses find that in the United States, value stocks have outpaced growth stocks by roughly 4–5 percentage points per year on average since 1927.

J.P. Morgan and Dimensional report 'about 4.4% per year,' and Fama-French academic research (the HML premium) reports levels of 'about 4.5–5.1% per year' depending on the period. This is commonly called the 'value premium.'

The figures differ slightly by source because periods and calculation methods vary. It's safer to understand it as 'historically in the range of 4–5 percentage points per year,' and there is no guarantee that the past gap will repeat in the future.

But recently, growth stocks won

Looking only at the history above, it sounds like 'value is the answer,' but the recent trend has been the opposite.

After the 2008 financial crisis, growth stocks led by large tech were strong, and the 2010s are counted as the first decade since the 1950s in which growth stocks completely outpaced for a full decade.

In other words, the performance of growth and value stocks 'cycles.' One side pulls far ahead for several years, and then it flips back the other way. That's why many investment textbooks explain holding both together to prepare for the cycle, rather than picking one of the two.

Knowing the style helps you understand the volatility

Growth stocks have a lot of future expectations priced into their share prices, so when expectations break, the drawdown can be large. In fact, when the dot-com bubble burst in 2000, the Nasdaq—crowded with tech growth stocks—fell more than -78% from its peak, and it took a long time to recover the principal.

Value stocks tend to be relatively less shaken, but when the market is enthralled by a particular growth theme, they can be left out for a long time and force you to endure tedious stretches.

Neither style offers a 'free lunch.' Just as their ways of generating returns differ, the shape of the risk you must endure differs too.

常见问题

Q. So which is better, growth stocks or value stocks?

There is no 'side that's always better.' Historically a long-term value premium has been observed, but for the past decade or so growth stocks have led. Because performance cycles, the winner changes depending on the point in time. That's why an approach of understanding the character of both styles and diversifying is often mentioned, rather than betting 100% on one side.

Q. Are growth stocks risky and value stocks safe?

Simplifying, that's a stretch. Growth stocks have large drawdowns when expectations break, and value stocks may have to endure long stretches of being left out. Neither is free of losses, and it's more accurate to see it as 'the shape of the risk is different' rather than 'less risk.'