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: October 14, 2026

Why your adviser must be a fiduciary   You should insist that your financial adviser be a fiduciary because a fiduciary is legally obligated, when acting in a fiduciary capacity, to put your interests ahead of their own and manage conflicts of interest appropriately. Key reasons: Your interests come first. A fiduciary duty requires the adviser to act in your best interest rather than simply recommending something that is suitable or profitable for them. Fewer conflicts of interest. Some advisers can receive commissions, bonuses, or other compensation for recommending particular investments or insurance products. A fiduciary must address material conflicts rather than allowing them to drive the recommendation. Greater transparency. Fiduciary advisers generally have obligations concerning disclosure, fees, conflicts, and how they are compensated. That makes it easier for you to understand what you're actually paying. Better alignment over the long term. A good adviser sh...
Post a Comment
Read more

Sound Advice: September 30, 2026

Now what? For many women, there comes a time when financial confusion reigns.   It may come after a spouse passes or a marriage goes off the rails.   It’s the same situation for women who never married. The questions are many.   The answers may be few.   Toward the top of the list of concerns is the issue of understanding.   Although there are always complex matters, it’s essential that all of the elements are clearly presented in a straightforward fashion.   There’s more.   Presentation is one thing, but comprehension is another. If there’s a question, it must be asked.   Clarity is the key.   Don’t just say I get it when you don’t.   And, it’s essential to grasp how each of the items fits in the overall situation. In the absence of understanding, no decisions will be made. Here are some of the most pressing questions? What’s the smart way to handle my investments? Where should I go for advice? A bank, stockbroker, attor...
Post a Comment
Read more

Sound Advice: September 19, 2026

Is AI good news or bad news for investments? AI is potentially very good news for investors—but not automatically good news for every investment . The key distinction is between AI as an economic technology and AI stocks at today's prices . As of September 2026, there are compelling reasons for both optimism and caution: The bullish case: AI spending remains enormous. Gartner estimates global AI spending at $2.7 trillion in 2026 , up 49.5% year over year. If AI produces sustained productivity gains, corporate profits could expand well beyond the companies currently selling AI hardware. The valuation case: Investors have already priced in a lot of success. Valuations of major AI companies are elevated and expected long-term earnings growth is well above historical norms. The spending-risk case: The five largest hyperscalers are expected to spend more than $1 trillion on AI-related capital expendit...
Post a Comment
Read more