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Investment Commentary: Hey Siri, Should I Invest in Value or Growth Stocks?

By Yuval Ezer, CFA®

The debate between Value and Growth stocks has recently intensified, especially given Value’s persistent underperformance compared to Growth and the rapid rise in long term interest rates as part of a regime change. This raises questions about whether a reversion to the mean will occur, or if more lasting changes are at play. One significant development influencing markets has been the rapid technological advancements disrupting various industries. These changes have led to the adoption of new business models, requiring investors to analyze new companies with fewer tangible assets and complex financials. Software, cloud technology, and digitization have played a central role in this revolution, contributing to the significant outperformance of Growth stocks relative to Value stocks over the past decade. Value stocks are characterized by lower stock prices relative to earnings and growth potential, typically demonstrating stable business models with modest revenue and earnings increases over time. Growth stocks, on the other hand, tend to have higher valuations, often measured by metrics like price-to-earnings ratios, and experience faster revenue and income growth.

Growth stocks have significantly outperformed Value stocks:

In his 1992 Chairman’s letter, Warren Buffett argued that Growth and Value are joined at the hip since growth is always a component in the calculation of value, so separating the two can be counterproductive. This argument is supported by the performance drivers of both Value and Growth stocks over the past decade. By analyzing the return drivers—earnings growth, dividend yield, and change in valuation multiple (P/E ratio)—we can see that Growth stocks have delivered superior fundamentals, driven by strong earnings growth rather than changes in valuation. In contrast, Value stocks have shown diminishing earnings power. For example, Google’s performance over the past decade was driven solely by strong earnings growth of 20%, while its valuation multiple actually contracted. Conversely, FedEx saw its earnings decline significantly over this timeframe, leading to poor performance.

We believe that the current trend is likely secular rather than cyclical, given the shift in the service economy, business models, and technological advances. Growth stocks should continue to outperform as long as they maintain strong fundamentals, especially considering that valuations haven’t expanded over the years. However, the recent change in the Fed’s rate policy, resulting in a higher cost of capital, suggests that we will likely see a more divergent performance from this group of stocks in the future. Meanwhile, we also see attractive opportunities in select Value areas, where share price performance has diverged significantly from stable fundamentals, so we intend to capitalize on these opportunities going forward. As a result, we believe that investors should consider exposure to both Value and Growth factors in their portfolios and be selective by focusing on the underlying business fundamentals.

Strong Fundamental Drivers Led to Growth Outperforming Value:

Looking ahead, we stand at the cusp of another wave of disruption driven by Artificial Intelligence (AI) and Machine Learning. These technologies are poised to revolutionize and disrupt numerous industries by enabling machines to learn and perform tasks that traditionally required human input. This development will fundamentally alter how information is analyzed and utilized, with big data playing a pivotal role in this transformation. While predicting the exact impact of AI on companies is challenging, we believe that access to proprietary big data would provide a competitive edge to companies with scale and reach. For example, Diageo, the world’s largest spirits company, has utilized real-time consumption data to enhance decision-making in areas such as revenue management, targeted marketing, and product innovation. This will be the next productivity and growth wave, which will likely be led by the so-called Growth stocks. Our approach is to incorporate a disciplined investment strategy that considers both the risks and opportunities arising from advancements in AI.

The past decade’s bull market has posed challenges for value managers, particularly with disruptions from new businesses and narrowing economic moats. We believe that focusing solely on the Value versus Growth dichotomy doesn’t serve investors well in a fast-changing world. Instead, understanding the underlying fundamental drivers of businesses is key to achieving long-term success. As long as businesses continue to deliver attractive growth prospects and trade at reasonable valuations, they should continue to outperform, and their stocks should follow suit.

Companies mentioned: Amazon (AMZN), Google (GOOGL), Salesforce (CRM), Exxon Mobile (XOM), Ford Motors (F), FedEx (FDX)

Shannon Dermody

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