Investors are facing a crucial decision as the debate between value and growth investing continues to evolve. While renowned investor Warren Buffett famously stated, “price is what you pay, value is what you get,” the reality is that investing in value stocks does not guarantee long-term success. Over the past decade, value stocks have significantly lagged behind growth stocks, raising questions about their future performance.
The divergence between these two categories is illustrated by the Russell 1000 Value Index and the Russell 1000 Growth Index, where approximately 30% of the stocks are represented in both indexes. This overlap reflects the complexity of categorizing stocks, as what constitutes value can be subjective. According to FTSE Russell, the remaining 70% of stocks are classified distinctly as either growth or value based on specific metrics.
For passive investors tracking broad market indexes like the S&P 500, these distinctions may seem irrelevant. However, they are vital for tactical investors and traders who seek to capitalize on market trends. Value investing has recently experienced a prolonged slump, prompting a closer examination of its underlying principles.
Defining Value and Growth Stocks
Value stocks are typically perceived as equities trading at a discount, evaluated through metrics such as price-to-book ratios and price-to-earnings ratios. In contrast, growth stocks usually command higher prices due to investor expectations of accelerated future profits. The classification of stocks into these categories is not straightforward, as evidenced by the practices of Russell, which assigns both growth and value weights based on various valuation criteria.
This complexity often leads to a misalignment between preconceived notions of growth and value as reflected in the respective indexes. Liz Ann Sonders, chief investment strategist at Charles Schwab, noted that the traditional definitions of these categories have shifted, particularly in the technology sector, which has seen an increased representation in value indexes.
The Historical Perspective on Value Investing
Despite its recent challenges, value investing is rooted in a well-established premise: purchasing stocks at lower prices is generally associated with higher expected returns. The equity investing team at Dimensional Fund Advisors emphasized that historical data supports this notion, showing that value stocks have outperformed growth stocks in the U.S. over the long term, often by a margin of 4.4% annually since 1927.
Recent performance trends, however, have deviated significantly from this history. For instance, the iShares Russell 1000 Value ETF (IWD) has returned less than 140% over the past decade, while the iShares Russell 1000 Growth ETF (IWF) has surged by more than 360%. This stark contrast marks a notable departure from historical performance trends.
While some may question the viability of value investing in today’s market, it is premature to declare it obsolete. The cyclical nature of stock performance, as noted by Hartford Funds, illustrates the importance of maintaining a balanced portfolio that includes both value and growth investments. Tactical allocation strategies, however, are best left to seasoned professionals who can navigate the complexities of market trends.
Investors seeking true value opportunities may need to look beyond broad indexes like the Russell 1000 Value Index, which may not serve as reliable proxies for identifying undervalued stocks. As the investment landscape continues to shift, understanding the nuances between value and growth investing will remain essential for achieving long-term financial goals.
