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- While growth and value stocks have historically traded off leadership roles, we do not think that a decisive shift towards value is in the works.
- We think that investing in competitively advantaged innovators is extremely important and that the best defense against potentially disruptive changes is to invest in them.
- While we are always interested in value investing opportunities, we see the overall picture as continuing to favor truly innovative growth.
Since the onset of the financial crisis in 2007, investors have tended to favor “growth” stocks over “value”. In a generally sluggish global economic environment, stocks capable of generating strong earnings growth have stood out for their relative scarcity. Given that growth and value have historically traded off leadership roles in the market, people may be asking whether the time has come for a regime change towards value. We do not think that such a decisive shift is in the works and see additional room for true growth innovators to thrive.
One important question when evaluating growth vs. value decisions is the level of premium valuation paid for growth. That is why we feel it is important to distinguish between levels of growth stock outperformance and levels of growth valuation expansion. Overall, the growth sector has seen superior revenue, earnings and cash flow growth compared to value in recent years, rather than simply seeing its relative multiple expand. In fact, the P/E multiple of the Russell 100 Growth Index relative to its value counterpart is well below the 25-year average (1.19X vs. 1.41X). Even excluding the dot.com bubble years of 1999-2001 from that history still puts the current level below the longer term average (1.19X vs. 1.30X).
Source: Columbia Threadneedle Investments, IBES Global aggregates, as of October 30, 2015.
Another factor in the growth vs. value decision is whether any major sectors are currently “under-earning”, potentially skewing the current data and view. Today, one would have to consider two major components of the value index in thinking through that question: financials and commodities (energy and materials). Financials, particularly banks, have been very challenged by low interest rates and a flat yield curve. A change in that dynamic might have a dramatic effect on bank profitability. Energy and basic materials prices have been battered by the intersection of global capacity increases and slowing demand growth, particularly out of China. Should there be a recovery in commodity prices, especially oil, the positive operating leverage in a recovery would be hard to ignore. This, in our view, would be the strongest case for a value recovery. That said, we would make two counterpoints: 1) a spike recovery in either case is not our base forecast and 2) current multiples would appear to already discount some level of recovery, particularly in energy. This is reflected in the relative discount of growth vs. value noted earlier.
Finally, we would emphasize the powerful innovative trends in American growth companies, most notably in technology software/services and healthcare. Not only are these businesses gaining global share of spending and, more importantly, profitability, but they are also disrupting traditional businesses, many of them “value” companies. Technology is allowing greater price transparency for the consumer (Amazon), greater utilization of assets (Uber), automation of labor (robots and artificial intelligence), and digitization of assets (Google and cloud-based systems). These trends are all pushing more of the profits in many industries away from traditional, capital-intensive processes and towards the “brains”. Given these disruptions on top of the forces of globalization and vast liquidity, we think that investing in competitively advantaged innovators is extremely important. The best defense against the potentially disruptive changes of these technologies is to invest in them.
Dividing the market in half and designating one part “growth” and the other “value” is clearly an imprecise exercise. We try to take a more granular look at the world, and we are always interested in “value” situations where capacity/supply has been removed by competitive forces and the stronger survivors can reap the benefits. However, we still see the overall picture as continuing to favor truly innovative growth.