Value vs. growth delineated by market cap

Chas Craig, BridgeTower Media Newswires

We first wrote about “Value vs. Growth” investing in August 2016, noting that value investors concern themselves with buying stocks deemed “cheap” with respect to their earnings or net assets while growth investors place a heavier weighting on a company’s prospects for strong future earnings growth. We revisited the distinction between these two investment “styles” in December 2017 after large-cap value stocks had underperformed large-cap growth stocks by a wider margin than at any other time except for the height of the tech bubble since the Russell Index series began in 1978.
Despite investors being recently underwhelmed by earnings reports from Netflix and Facebook, two of the notorious FAANG (Facebook, Amazon, Apple, Netflix and Google) stocks that have been outsized contributors to the post-crisis bull market, growth stocks have continued their yearslong rout of value stocks in 2018. This fact has been widely reported in the media, but what has gone nearly unreported is that the “growth kills value” story is very large-cap-centric.

Courtesy of Russell Indices, please see the annualized return figures for U.S. stocks delineated by size and style over the past three years below:

As you can see, the underperformance of value stocks relative to growth stocks has been driven by the divergence in fortunes within mid and especially large caps, as small cap value stocks have actually outperformed their size cohort and the overall market (i.e. Russell 3000) over the period.

Regarding small value versus large value, while President Trump’s meeting last week with EU Commission President Jean-Claude Juncker provided hopes for a détente between those trade partners, the trade war fears of recent months have caused investors to prefer more domestically focused small caps over multinational large caps that have international supply chains and rely more heavily on exports. The level of outperformance for small cap value over large cap value in recent months is comparable to that of the period just following the surprise election result of November 2016 when Mr. Trump’s “America First Agenda” was front of mind.

As it pertains to small cap value versus small cap growth, the sectors positioned best to reap the benefits of the Trump administration’s economic policies, particularly industrials and financials, are more represented in value than growth indices. While small value’s outperformance of small growth has meaningfully narrowed, the jolt received at the end of 2016 was so pronounced that it has not yet been fully overcome. This, of course, is not true at all within the large cap space where large value stocks lost their “Trump Bump” relative to large growth stocks in a matter of a few months.

Parting thought: No stock, sector, style or market cap segment can produce market-beating results into perpetuity. From a profitability perspective, in free markets, excess profits eventually get competed (usual course) or regulated (i.e. antitrust cases) away. Also, valuations matter a lot over the long-term, and higher valuations (i.e. P/E ratios) are associated with lower prospective rates of return.

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Chas Craig is president of Meliora Capital in Tulsa (www.melcapital.com).