Value Investing Trend Shows Investors Should Consider Diversified Investments

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Growth investing and value investing are generic terms used to describe the investment approaches to the stock market. A critical look at the stock attributes would imply that this dichotomy is not straightforward in practical terms, as some stocks share both characteristics. This did not excuse the fact that the growth-value subject has been a fierce debate among industry analysts and participants, perhaps dating back to the origin of the stock market itself.

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Value Investing vs Growth Investing

Growth companies focus on morphing from small start-ups to industry leaders within the shortest time. Because of this approach, they sacrifice profit for an increase in revenues at the earlier stages of their inception, reverting when they believe they have reached their revenue target.

Growth stocks refrain from dividend payments, choosing instead to reinvest earnings back into the company. Based on this attribute, Growth investors look for companies that offer strong earnings growth and a good chance for considerable expansion over the next few years. Growth companies usually have higher valuations as measured using financial metrics such as price-to-earnings or price-to-book value ratios. Because of their fast momentum, they are typically volatile, unpredictable and could swing both ways in a relatively short time.

Value investors look for undervalued stocks in the marketplace. Benjamin Graham, who is the pioneer of value investing, proselytized this investing. Legendary investor Warren Buffett is a firm adherent of value investing, famously referred to as cigar butt investing. The premise is that value companies offer investors the opportunity of buying shares below their actual value and typically can appreciate in market capitalization. Value companies are not flashy and absolved from the fanfare and razzmatazz that usually tails growth companies. Value stocks are relatively steady and predictable, recording models gains in revenue and earnings. Even if they trade at attractive prices below their fair value, they may still offer some capital growth because they pay dividends.

Which Investment Style Is Better?

For a long time, the argument of which investment style is better has been the source of heated debate in the financial world. By better, we mean returns on investment. One way to settle this rancorous debate is by looking at historical charts and data. Findings using this parameter show that growth stocks have outperformed value stocks by a wide margin over the last decade. If we consider the way the market has reacted to both investment styles this year, it will affect value stocks for a long time.

Data from the S&P global index shows that while growth stocks have returned 13.85% on investments over a decade, value stocks have returned 6.55% (as of September 25, 2020), implying that growth stocks have performed more than twice as better as value stocks. The scenario for value investors gets worse as we contract the timeframes. As shown in the chart below, growth stocks have outperformed value stocks by 12 times using the five years.

While the growth index has 13,997.24 (12.11%) basis points, the value index has only attained 4,836.28 basis points in the same period (-0.06%).

In the last five years, while the Russell 1000 Growth index has increased over 100%, the Russell 1000 Value index has only managed a 23% increment. According to the CNBC, referencing a study carried out by Bank of America, this decade has seen the most dismal performance for value stocks, which have performed worse than the 1929 depression and dotcom bubble.

Sectors Beaten Down By The Effects Of The Pandemic

Included in this metric are sectors that have been beaten down by the effects of the pandemic, including retail and travel. There is no doubt the hospitality industry must evolve to remain relevant. With travel sentiment down, hospitality companies may struggle for a long time before getting back to pre-pandemic levels.

Airline and cruise bookings have extended to 2021, giving consumers an opportunity to reschedule travel plans. In addition, timeshare companies have struggled to keep consumers happy as booking reservation cancellations peak.

In 2019, timeshare sales increased 7% to $12.5 billion as the vacation club industry recorded its 10th straight year of growth. With looming effects of the pandemic in play, timeshare leaders will need to maintain cash reserves and flexible booking structures while offering backup plans if customers wish to cancel within brief notice.These measures can prevent a flurry of litigations witnessed earlier in the year. When customers are booking vacations, they should have various options to care for any emergency or unforeseen circumstance, such as rescheduling bookings. Companies can also offer to buy back their shares.

However, it is not as simplistic as it looks. If this breaks down to sectoral size, we can get a clearer picture of catalysts responsible for this widening gap and therefore make better inferences.

Underperformance Of Value Stocks Attributed To The The Financial Crisis Of 2008

From analyzing historical charts, we can see that financials are the largest part of the value index, whereas technology stocks make up the largest part of the growth index. JP Morgan attributes the underperformance of value stocks since 2007 to the financial crisis of 2008 and the low-interest-rate environment that has persisted in its aftermath. While it has forced banks to increase capital levels to improve financial stability after the crisis, this has also reduced their return on equity. Investors who once thought individual financial institutions were too big to fail have had a rethink. Investor confidence since then is yet to reach has not yet gotten to post-financial crisis levels.

The last decade has also not been favorable to energy stock, the second biggest sector in value stocks. Oil is yet to reach its 2009 levels when it sold for more than $100 per barrel. Awareness of global warming, which has spurred calls for a shift towards cleaner energy, has put pressure on nations to find alternative means of power. India has set a 2030 time limit for the use of diesel-powered cars. The UK and France have set a 2040 target for a complete ban on gasoline and combustion engine vehicles. Roughly 40% of cars sold in Norway were electric or hybrid. This month, California set a 2030 time limit that is further worsened by a supply glut in the market (which has reduced oil prices). April this year marked a significant point in the oil industry when the WTI went negative for the first time.

Technology stocks have benefited immensely from the disruption of traditional modes of doing things. Companies such as AMZN, NFLX, SPOT, TSLA have all seen a surge in their share price and valuations because of their disruptive tendencies. NFLX changed the movie market, TSLA, with its push for EV cars, which has disrupted the automobile industry. AMZN and SPOT altered the face of shopping and music streaming, respectively. These companies riding on technology, which makes their services easier and accessible to people, have seen tremendous growth—allowing them to deliver phenomenal sales and income growth.

Technology has been a pacesetter in contemporary human civilization, dictating the type and pace of change. It has brought about a shift in tastes, work patterns, business models, and communication modes. Unlike other sectors that have to adapt to consumer needs and preferences, people have to adapt to current technology, making technology gadgets in demand, which ultimately drives up revenue and profitability of tech companies.

While analysts have been slow to dismissive the change predominant narrative towards stock investing, which has always favored value investing over growth investing, they may well be waiting for a long time for the rotation back to value investing. They can at least take solace because value investing has outperformed growth investing in the last 30 years. But such performance is fading in our memories like a light, further receding into darkness. Growth investing may well be the new investment mantra.