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: July 8, 2020

Jobs Are Up, But So Are New Infections Through the spring months, m ost of the economic data was extremely negative, with record declines in employment and consumer spending.  The speed of that decline had no modern precedent. We are now in a recession.   The shortest recession on record occurred in 1980 and lasted just six months.  Second place goes to a seven-month recession in 1918-19, which was tied to the Spanish flu pandemic.  The big question is: When will this recession end? Given surprisingly strong data in May, April may have been the bottom of this economic cycle.  If so, it will have been the shortest recession on record.  With massive support from the Federal Reserve, the federal government, and the reopening of previously closed businesses, employment surged unexpectedly.  At the same time, pent-up demand, stimulus checks, and generous unemployment benefits led to a reacceleration of commercial activity. Still, not all is rosy.   In his recent testimo
Post a Comment
Read more

Sound Advice: December 13, 2023

What You Need To Know About Long-Term Care Insurance Long-term care insurance (LTCI) is a type of insurance that helps cover the costs of long-term care services, such as assistance with activities of daily living (ADLs) such as bathing, dressing, and eating. It can also cover the expenses associated with care in a nursing home, assisted living facility or at home by a professional caregiver. Here's what you need to know about long-term care insurance: 1. Not Covered by Health Insurance or Medicare: Long-term care services are generally not covered by health insurance or Medicare, which only provide limited coverage for skilled nursing care and rehabilitative services. Medicaid covers long-term care, but you need to meet strict income and asset requirements. 2. Costs of Long-Term Care: Long-term care can be expensive and can quickly deplete your savings. LTCI helps to cover these costs, providing financial security and ens
Post a Comment
Read more

Sound Advice: December 6, 2023

Some Suggested Financial Adjustments for Retirees Financial adjustments for retirees are crucial to ensure a comfortable and secure retirement. Here are some worthwhile financial adjustments and considerations for retirees: 1.      Create a Budget: Establish a realistic budget based on your retirement income and expenses. Categorize your spending and prioritize essential expenses such as housing, healthcare, and groceries. 2.      Emergency Fund: Maintain an emergency fund to cover unexpected expenses. Aim for at least three to six months' worth of living expenses. 3.      Healthcare Costs: Be sure to fully understand your healthcare coverage and consider supplemental insurance plans to cover gaps in Medicare. Account for potential long-term care expenses as well. 4.      Minimize Debt: Aim to pay off high-interest debt before retiring. This can significantly reduce financial stress and free up more of your retirement income. 5.      Investment Diversification: Div
Post a Comment
Read more