The Dow and SP 500 have achieved new highs this year. Given anemic or no returns on bonds, money market and gold, it is somewhat unlikely that, in the absence of a major shock, the equity rally will dissipate in the short-term. Should we then use the pause in the market rally to evaluate our investing style in order to maximize returns going forward?

The value style looks for companies trading at a discount to their intrinsic value with good dividend stream and low valuation multiples. Value funds therefore search for hidden beauties where the stock price is lower than the inherent worth (i.e., present value of discounted projected cash flows), thereby providing a margin of safety to the investor. The growth style, on the other hand, typically involves investing in companies with rapid growth of earnings, retention of profit and high P/E ratios. While value funds generally do better in market downturns, growth leads in a rally.   

Value and growth investing are not mutually exclusive. Warren Buffett, in fact, prefers a combination of the two in the sense that his selected companies are able to grow their upcoming earnings fast enough but are still available at a discount to their intrinsic value.

In particular, the ‘dividend growth’ investing style captures the virtues of both growth and value investing. This methodology involves investing in companies that are able to grow earnings rapidly enough so as to engage in frequent dividend hikes but are still available at moderate valuations.  

Growth investing boomed in the late 1990s, when investors scooped up new age stocks with no earnings or cash flows at steep premiums. After the bubble burst, value investing dominated till the Great Recession of 2008 set in. The Lehman crisis heralded another change in investing style with the growth investing style taking center stage.

Eugene Fama and Ken French showed that large value (average return of 11.9% per annum) handily beat large growth (9.2% per annum) over the prolonged period from 1928 to 2004. It has, however, been estimated that value shares have lagged growth shares by over 20% over the last 16 or so years. Over a shorter time frame (past 5 years), the Russell 3000 Growth has given an annualized return of 6.75% compared with just 4.36% for the Russell 3000 Value. Clearly, value investing has a lot of ground to recover vis a vis the growth style before a value premium re-establishes again.

Should the current accommodative monetary policy driven stock market rally taper off, then a bottom up stock picking approach, as in value investing, may look attractive, keeping your investment horizon in mind as always. 

To sum up, higher growth rates may not always lead to enhanced investment returns as markets may be efficient at factoring in growth prospects. That may help explain why some bourses in faster growing emerging markets have been flattish this year. According to this school of thought, returns are linked with risk, not growth.

Most considered Apple Inc. (AAPL) to be a growth stock, till it fell far enough to become a value stock. Our perusal of the composition of some value oriented mutual funds reveals holdings in financial services, eg., JPMorgan Chase Co., (JPM); telecom, eg., Verizon Communications Inc., (VZ); consumer staples, eg., Procter Gamble Co., (PG) and energy, eg., Exxon Mobil Corporation, (XOM). 

Read the Full Research Report on JPM

Read the Full Research Report on PG

Read the Full Research Report on AAPL

Read the Full Research Report on XOM

Read the Full Research Report on VZ

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