Value vs Growth – it’s one of the great investing debates. But what does it mean?
Let’s start with some definitions:
- Growth investing - growth investors seek out companies whose earnings are expected to grow relatively strongly over time.
- Value investing - value investors are typically more price than growth focused - preferring to own companies they believe the market has undervalued.
It’s all about how investment managers evaluate stocks. That’s why value and growth are often described as investment ‘philosophies’. A company may be a value stock now and a growth stock in five years time – the difference depends on factors such as price, earnings growth, debt and a range of other measures. The essence of the debate is an assessment of the current characteristics of the company – and how that drives your investment choices.
We’re voting value
Perpetual have been value investors for decades – indeed the Perpetual Industrial Share Fund has had a value-based investing approach for nigh on 50 years. Chart 1 shows the performance of the US S&P 500 Value and Growth indices over the 40 years to early 2016. As you can see, an investor in the Value index would have done better over this long-time frame.
Chart 1: Value vs Growth indices from 1976 to 2016 [i]
Interestingly, that hasn’t been true over the past few years. Since the GFC, growth stocks have outperformed value stocks. In this article we want to look at why this happened and why we believe 2016 could be the year that value reasserts its historic superiority.
Source: World Bank & Trading Economics.
*average of 1994-2014
We’re going on a yield hunt
In the wake of the GFC, the world has been characterised by low economic growth (see table above) and low rates. With cash, term deposits and bonds delivering lower yields, many investors have turned to shares paying high dividends.
In our view Telstra is a prime example – since 2011 its price has doubled, yet earnings have not significantly grown. We believe, investors are treating Telstra like a bond because of its high, predictable earnings stream and strong dividend yield.
Indeed, since 2009 it’s likely many investors have focused their equity holdings on ‘defensive’ stocks:
- Utilities and Infrastructure stocks for their oligopoly features
- Consumer Staples for their reliable earnings
- Healthcare companies for their favourable industry tailwinds – including earnings underpinned by government funding.
While many believe these are safe investments this trend has left some investors exposed to significant risk by paying inflated prices for these stocks.
We believe you can see this issue in microcosm when we look at toll road operator Transurban (TCL),. On the latest Consensus estimates for the 2017 financial year (as at May 2016) the company is paying a dividend yield of 3.8%. This may look relatively attractive when compared to term deposits and bond yields. However, the price to earnings ratio is 75x forecast earnings. What’s more, the company has in excess of $11 billion in net debt.
2016 – The return of value investing?
Bank of America Merrill Lynch (BAML) Global Research has forecast that 2016 will be the year that value investing outperforms growth once again. BAML is expecting higher interest rates and better growth in profits in 2016, driven by a strengthening US dollar and lower oil prices. Based on their research, a 5% or greater increase in profits has historically been accompanied by value strategies outperforming growth 71% of the time. BAML is forecasting a 5% increase in profits for 2016.
Perpetual – how we performed in a tough market for value
Perpetual has performed well since the GFC. Perpetual manages Australian and global equities, fixed income and multi-asset strategies. Value is at the core of our investment approach in all these asset classes, yet over the past five years every Perpetual investment strategy has ranked in the top quartile in its respective investment universe (see chart).
Quartile Performance: FUND WEIGHTED % OF FUNDS OVER 1 – 10 YEARS)
One reason for Perpetual’s performance is our focus on quality. A share may be cheap but not necessarily good value. Some companies stay cheap due to challenging market dynamics, a weak financial position or inferior management. Perpetual has delivered good relative performance by buying quality companies and avoiding “value traps”.
The bottom line – value and quality and experience
In our view, global sharemarkets are currently facing weak economic growth and weak earnings potential. Couple this with full valuations and nervous investor sentiment, and it looks more likely than not that recent volatility will continue. However, that volatility can push down the price of quality stocks – which may create opportunities for better returns in the long run. Our time-tested value investment process and focus on quality means Perpetual is well positioned to help investors navigate this challenge.
Want more information on Perpetual’s share investing process?
Or download the full Value or Growth White Paper.
The author is an employee representative of Perpetual Investment Management Limited ABN 18 000 866 535 AFSL 234426. This information has been prepared by Perpetual Investment Management Limited (PIML) ABN 18 000 866 535, AFSL 234426. It is general information only and is not intended to provide you with financial advice or take into account your objectives, financial situation or needs. You should consider, with a financial adviser, whether the information is suitable for your circumstances. To the extent permitted by law, no liability is accepted for any loss or damage as a result of any reliance on this information.
[i] Note: Past performance is not indicative of future performance and no company in the Perpetual Group guarantees the performance of any fund or the return of an investor’s capital. Current performance can be obtained from our website or phoning our call centre on 1800 022 033.