Skip to main content

Sound Advice: May 26, 2021

Growth vs. Value?

One of the longest-running dichotomies in investing is the ongoing tug of war between growth stocks and value stocks.  Growth stocks are generally seen as companies that are growing consistently and, typically, at above average rates.  Value stocks, on the other hand, are companies whose progress is less consistent and often relatively slow. 

At first glance, one wonders why investors would look beyond growth stocks to fill out their portfolios, but there’s more to the task of portfolio construction than just picking market stars such as Amazon, Apple, Facebook, and the like.

Here’s the hitch.  Over time, most growth stocks will turn in better returns than most value stocks.  The key word here is most.  A portfolio of diversified growth stocks will usually be selling at significantly higher valuations (price-earnings ratios) than a portfolio of diversified value stocks.  Why?  Because more rapid and more consistent growth rates give investors greater confidence that these patterns will continue.  That confidence is the reason why they will pay more.

The problem is the tendency of growth stock valuations to get stretched beyond reasonable levels.  In Wall Street parlance, that situation is referred to as “priced for perfection”.  These rich valuations lead to the risk of major, rapid price plunges if there are earnings shortfalls or other negative business developments within companies.  In these cases, the impact of even one such drop will markedly bring down the average performance of the entire portfolio. 

Value stocks demonstrate the flip side of this equation.  In reflection of their relatively mediocre financial and market performances, their valuations tend to be quite lean.  Investors don’t expect much from them and exhibit that expectation by buying only when they are relatively cheap.  When earnings are weak or there’s disappointing news, not much happens . . . unlike the case with growth stocks.

Yet every now and then these companies announce results that are well above what had been expected and their shares rise dramatically.  Not surprisingly, when this happens in a diversified portfolio of value stocks, the average performance jumps, often beyond that of growth stock portfolios.

In many ways, this is a mirror image of what’s known as the Dogs of the Dow Theory, which is based upon annual portfolio rebalancing and concentration on the highest yielding stocks in the Dow Jones Industrial Average.  It’s also akin to the popular high dividend yield approach (using a broader universe than the Dow).  

The common denominator for all of these is the importance of having a broadly diversified portfolio to increase the opportunity for positive surprises and limit the exposure to downside disappointments.

N. Russell Wayne, CFP®

Sound Asset Management Inc.

Weston, CT  06883

203-222-9370

www.soundasset.com

www.soundasset.blogspot.com

 

Any questions? Please contact me at nrwayne@soundasset.com

Comments

Post a Comment

Popular posts from this blog

Sound Advice: January 3, 2025

2025 Market Forecasts: Stupidity Taken To An Extreme   If you know anything about stock market performance, you can only gag at the nonsense “esteemed forecasters” are now putting forth about the prospective path of stocks in the year ahead.   Our cousins in the UK would call this rubbish.   I would not be as kind. Leading the Ship of Fools is the forecast from the Chief Investment Strategist at Oppenheimer who is looking for a year-end 2025 level for the Standard & Poor’s Index of 7,100, a whopping 21% increase from the most recent standing.   Indeed, most of these folks are looking for double-digit gains.   Only two expect stocks to weaken. In the last 30 years, the market has risen by more than 20% only 15 times.   The exceptional span during that time was 1996-1999, which accounted for four of those jumps.   What followed in 2000 through 2002 was the polar opposite: 2000:      -9.1% 2001:     -11.9% ...
Post a Comment
Read more

Sound Advice: March 10, 2021

The ABCs of Stock Picking After decades of analyzing stocks (and funds) and investing for clients, I'm happy to share in plain English what's involved, what works, and what doesn't.  Keep in mind the reality that successful stock picking is an effort to maintain a good batting average. In baseball, a batting average of .300 or better is considered quite good.  With stock picking, you need to do better than .600, which means you have many more winners than losers. No one gets it right all of the time.  It's not even close.  Wall Street shops all have their recommended lists and the financial media regularly hawk 10 stocks to buy now. Following that road usually is a direct route to disaster.  Don't be tempted. Let's begin with the big picture: The stock market goes up and down over time, but the long-term trend is up.  When there's a rally under way, everyone feels like a genius.  When the market hits an air pocket, though, with few exception...
Post a Comment
Read more

Sound Advice: June 17, 2020

Rock and a Hard Place Regardless of your age, impressions from childhood linger.  As the first days of summer approach, we all remember the feeling that accompanied the end of a school year.  Yet as much as many of us would like to believe we again have the summertime freedom to do as we wish, the reality is quite the opposite. Although months of confinement and limitations on social interaction have increased our personal discomfort and severely impacted the business community, our current situation is not analogous to the end of any school year.  It’s quite the opposite. There is every reason to continue wearing face masks, social distancing, and avoiding close contact with others.  Nothing suggests that we can modify our behavior significantly or resume patterns of daily living we enjoyed only a few months ago. There are no meaningful advances in medical treatments.  At best, there are attempts to combine different approaches...
Post a Comment
Read more