Is value finally making a comeback?

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The fourth quarter of 2020 proved a momentous one, most notably as the beginning of the end of the COVID-19 pandemic. With several approved COVID-19 vaccinations, countries began to undertake a herculean task of manufacturing, distributing, and inoculating hundreds of millions of citizens in record time, the significance of which cannot be understated.

Vaccine news dominated the market for much of the quarter and a change in stock market leadership began to emerge as downtrodden value stocks soared, handily outpacing growth stocks during the quarter—the Russell 1000 Value index returned 16% during the fourth quarter against an 11% return for the Russell 1000 Growth index. This is good news for investors who have waited nearly a decade for this shift, but will it persist?

Before diving into historical return patterns and last quarter’s returns, a review of growth versus value is necessary to set the stage.

What’s in a name: Growth vs value

Broadly speaking, growth stocks are those that have demonstrated stronger-than-average earnings growth in the past, a trend which is expected to continue. Value stocks tend to be those that have fallen out of favor, meaning their share prices are likely to have dropped off, though investors believe the situation to be temporary. Those divergent classifications lead to distinct characteristics of growth and value stocks.

VALUATION

Growth stocks tend to have valuations that are higher than the broader market because investors are willing to pay up for above-average future growth prospects. Because value stocks have typically fallen out of favor (or have been left behind in a market upswing), the valuations tend to be lower. Investors need more enticement to purchase shares of companies whose future growth prospects are less clear. There are several valuation techniques that can be utilized but the most common are price-to-earnings, price-to-book, and price-to-sales.

HISTORICAL AND FUTURE GROWTH ESTIMATES

As the name suggests, growth stocks should have higher historical and future growth rates (earnings, sales, cash flow, etc.) than the broader market. Within growth stocks, there are degrees of “growthiness” with higher octane names growing at much faster rates than the broader market. On the flip side, value stocks tend to have lower growth rates, both historical and expected. 

YIELD

Another differentiator between growth and value is yield (dividend/share price). Value stocks often have higher yields than growth stocks. This is primarily because value stocks tend to be more mature (and therefore slower growing) companies and are more likely to pay a dividend. When faced with a choice between re-investing capital or paying a dividend to shareholders, more mature firms may decide that paying dividends is a better value-add for shareholders. Less mature growth companies, on the other hand, might have less cash on hand to begin with and may find re-investing back into the business a better long-term value proposition for shareholders. It’s important to note that not all value stocks pay dividends and many growth stocks do.

SECTOR ALLOCATIONS

Because certain types of firms tend to exhibit similar characteristics, a clustering by sector results. The Russell indexes are popular domestic stock indexes that capture both the size and style variants in the stock market. The Russell 1000 includes the largest domestic stocks while the Russell 2000 includes the smallest domestic stocks. The below chart shows the sector allocations as of the end of 2020 for each of the Russell growth and value indexes.

Sector allocations for Russell Growth and Russell Value indexes

Source: Morningstar. Past performance is not indicative of future results.

Most significantly, all three growth indexes have much larger allocations to technology stocks and smaller allocations to financial services stocks than their value counterparts. Those two sectors alone have been a huge driver of return differentials over the last several years as technology stocks have soared and bank stocks have stagnated. Energy and utilities are also areas where value stocks tend to cluster. Both sectors have trailed the broader market for some time.

Total returns for Russell Growth and Russell Value indexes
  Total Return (%)
  Q4 2020 2020 2019 2018 2017 2016 2015 2014 2013 2012 2011 2010
Russell 1000 Growth 11.39 38.49 36.39 (1.51) 30.21 7.08 5.67 13.05 33.48 15.26 2.64 16.71
Russell 1000 Value 16.25 2.80 26.54 (8.27) 13.66 17.34 (3.83) 13.45 32.53 17.51 0.39 15.51
Russell 2000 Growth 29.61 34.63 28.48 (9.31) 22.17 11.32 (1.38) 5.60 43.30 14.59 (2.91) 29.09
Russell 2000 Value 33.36 4.63 22.39 (12.86) 7.84 31.74 (7.47) 4.22 34.52 18.05 (5.50) 24.50
Russell Mid Cap Growth 19.02 35.59 35.47 (4.75) 25.27 7.33 (0.20) 11.90 35.74 15.81 (1.65) 26.38
Russell Mid Cap Value 20.43 4.96 27.06 (12.29) 13.34 20.00 (4.78) 14.75 33.46 18.51 (1.38) 24.75

Source: Morningstar. Past performance is not indicative of future results.

During the fourth quarter, all three value indexes outpaced their growth counterparts. While it may be tempting to take this quarter’s events as a sign that value is finally coming back, this wouldn’t be the first false start for value stocks in recent memory—2016, for example.

While value stocks might outperform in the short run due to the disparity in recent returns, it remains prudent to maintain a modest overweight to growth stocks for most investors. Given the long-term outperformance and the higher future growth prospects for growth stocks, investors in the early stages of their investing lives can especially benefit from this stance.

Source: Morningstar.  Important Information: The Russell 1000 Index is a broadly diversified index made up of top companies by market capitalization in the United States. The S&P 500 Index is a market-capitalization-weighted index of the 500 largest U.S. publicly traded companies. The Russell 1000 Growth Index is a broadly diversified index predominantly made up of growth stocks of large U.S. companies. The Russell 1000 Value Index is a broadly diversified index predominantly made up of value stocks of large U.S. companies. The Russell 2000 Index is a composite of small cap companies located in the United States. The Russell 2000 Growth Index is a composite of small cap companies located in the United States that also exhibit a growth probability. The Russell 2000 Value Growth Index is a composite of small cap companies located in the United States that also exhibit a value probability. The Russell Mid Cap Growth Index measures the performance of the mid- cap growth segment of the US equity universe.  The Russell Mid Cap Value Index measures the performance of the midcap value segment of the US equity universe. The indices are unmanaged and does not incur management fees, transaction costs or other expenses associated with investable products. It is not possible to directly invest in an index.

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