Equity portfolio managers are often split into two groups: growth and value. At a high level, these labels refer to the philosophy each follows when selecting investments. While both groups seek to maximize returns, they do so in their own unique way. This article will review the general features of each style of investing.
What it is: Value investors are often thought of as bargain hunters. Their strategy is to invest in stocks that are trading below their actual worth – profiting once the market corrects this gap.
Mantra: Buy quality businesses at discounted prices.
What it is: Growth investors prefer the high-flying segments of the market. They seek out companies that are expected to enjoy significant growth – relative to their industry or broader market. The profit comes as the company achieves this vision.
Mantra: Pay a premium for businesses based on expectations for high levels of future profitability.
Where are the growth and value corners of the market?
It’s important to remember that there is no fixed definition of what makes a growth or value stock. In many ways, value and growth are in the eye of the investor. That said, style indices can add some clarity. As an example, let’s look at each of the characteristics of the Russell 3000 Index – a broad measure of the U.S. equity market -- and two of its sub-style indices, the Russell 3000 Value Index and the Russell 3000 Growth Index.
Source: RBC GAM, FTSE Russell. Data as of November 30, 2020.
The price-to-book ratioThis measures the current market price of a company’s stock to the calculated value from its balance sheet. A low ratio tends to indicate a value stock. It implies a disconnect between the market’s perceived value of a company and its net assets.
The dividend yieldThis measures how much a company pays out in the form of dividends relative to its stock price. Value companies are typically mature, with stable earnings. This means they often return higher dividends to investors. Meanwhile, growth companies often reinvest earnings into their operations to drive future expansion – resulting in a lower dividend yield.
The price-to-earnings ratioThis indicates how much investors are willing to pay for each dollar of a company’s earnings. Not surprisingly, this measure is higher for the growth index – reflecting the premium investors place on these companies.
Relative sector exposure
But there’s more. The chart below shows how the weighting of sectors held within the Russell 3000 Value Index compares to the Russell 3000 Growth Index.
Source: RBC GAM, Bloomberg. Russell 3000 Value Index and Russell 3000 Growth Index, data as of November 30, 2020.
This comparison highlights a number of differences between the two styles.
- Value tends to be underweight the technology sector. This is largely due to the two largest companies in the growth index: Apple and Microsoft. These companies tilt the scales strongly toward technology for growth investors.
- Value has more exposure to economically sensitive, cyclical corners of the market. For example, the value index is overweight in the Financials, Industrials, Energy, and Materials sectors.
Where to go from here? It all comes back to diversification…
No matter how you invest, it’s important to remember that markets can shift quickly. The cyclical nature of markets means different styles will lead at different times. Taking a diversified approach – with exposure to various corners of the market -- can provide you with a smoother investment experience than one that centers heavily on any particular style.