Why the good time for growth stocks may not be over

Many investors believe it’s time for value stocks to take the lead. Not so fast.

  • By John Coumarianos,
  • The Wall Street Journal
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Growth stocks are on an uncommon roll as corporate profits chug on. But you might not want to bet on this long winning streak ending soon.

In a landmark 1992 paper, Profs. Eugene Fama and Kenneth French published data showing that small and value stocks (originally defined as low price to book value) had beaten the market over many decades up to that point. Investors who tilted their portfolios toward value in response were rewarded, somewhat, in the years since then.

Value investing guide

Follow these rules when sizing up a stock, whether it's a growth stock or a value stock.

There is a lot of cyclicality over that period, though, with value and growth trading the lead over shorter spans. But over the past decade, growth has smashed value. For the 10-year period ended in 2018, the Russell 1000 Growth Index (.RLG) delivered a 15.3% annualized return compared with the Russell 1000 Value Index’s (.RLV) 11.2% performance.

Nobody knows how long these different cycles can last, but it’s reasonable to think that a decade is a long time in terms of market cycles. Some market watchers have been calling for a value rebound for a while now.

Growth won’t quit

Some thought value had begun its rebound in 2016 when the Russell 1000 Value Index returned 17% and the Russell 1000 Growth Index returned 7%. But growth came screaming back in 2017 with the growth index returning 30% against 14% for the value index. And in 2018, when broad market indexes were down—a time when growth stocks usually drop more than value stocks—growth outperformed again, with the growth index losing a mere 1.5% against the value index’s 8.3% swoon.

Nobody can say by how much value is supposed to outperform growth. Since 1995, the Russell 1000 Value Index has beaten the Russell 1000 Growth Index by around one-third of 1 percentage point annually.

The current dominance by growth stocks may suggest that something has changed in the years since the Fama/French paper was published: namely, the huge profitability for growth stocks. Unlike during the dot-com boom, when many fledgling technology companies didn’t have revenue, much less earnings, the current top-10 holdings of the Russell 1000 Growth Index sport average five-year returns on invested capital—as calculated by Morningstar Inc. —of nearly 23% for the past five years. That eye-watering profitability makes the firms’ average current price-to-earnings ratio of around 32 easier to swallow than it might be with more ordinary returns on capital and margins.

Political wild card

Indeed, if growth stocks and their investors are vulnerable today, it may not be because of pie-in-the-sky valuations anticipating profit growth that will never materialize. Instead it may be that the extreme profitability of many companies has been attracting unfavorable political attention. At least one presidential candidate, Democrat Elizabeth Warren, has been arguing for stronger antitrust enforcement including the breakup of technology companies like Facebook .

Investing on political beliefs or forecasts, however, rarely leads to a good outcome. Investors seeking exposure to large and medium-size U.S. stocks can get it through something like iShares Russell 1000 exchange-traded fund (IWB). This ETF makes no value or growth bet and counts Exxon Mobil (XOM), Johnson & Johnson (JNJ) and JPMorgan Chase (JPM) among its top holdings, along with more glamorous and more highly profitable companies including Apple (AAPL), Facebook (FB) and Google parent Alphabet (GOOGL).

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