Growth vs value

There is a lot of debate at the moment as to whether investors should be favouring growth or value. There’s a lot of talking heads telling us what the “pros” have been rotating in and out of, and what the indices have and haven’t done. There’s very little advice on what you should do.

For example:
* The Sunday Times reports today that Richard Buxton reported last summer that we could be at the start of a new 15-year bull cycle. (http://is.gd/t5k082)
* The Wall Street Journal reported on 3 April that “Value Stocks Head Higher as Growth Companies Look Pricey” (http://is.gd/0gh356)
* John Tobey at Forbes reported last month that “Ignore Momentum Advice
– Buy Real Growth Stocks” (http://is.gd/MeMWix). “The momentum stock sell-off does not mean we need to run from growth stocks. The best 2014 strategy is quite the opposite.”
* CNBC reported in late April “With the wipeout in growth stocks, many investors turned their attention to big-cap and value names, and the trend is expected to continue for months to come.” (http://www.cnbc.com/id/101599397)
* Ben Hobson on Stockopedia seems to favour quality income: “a slight softening in prices has re-opened the taps for good quality stocks offering forecast yields of more than 4%. For subscribers looking for income ideas now – perhaps with the new year’s ISA allocation in mind - this might be a good place to start.” (http://is.gd/OFhavh)
* Matthew Boesler at Business Insider reported in mid-April: “The stock market, but not momentum stocks, will likely recover during the next few months” (http://is.gd/ji83kD)

So, who’s right, if any?

Look at the 5-year chart showing the T1X (Techmark Index), LIX (Low Yield Index), and HIX (High Yield Index).

 

If we take T1X and LIX as proxies for growth shares, and the HIX as a proxy for value shares, then clearly growth has outstripped value. Under an assumption of mean value reversion, this would imply that
value should outperform in future.

A similar picture emerges is we look over 10 years:

 

However, if I draw a chart from near the end of December 1999, we see that growth has actually underperformed value:

Have I shown malice-aforethought in carefully choosing my starting point to prove whatever I want? Maybe, but it does show the inherent dangers of choosing your starting points.

Stockopedia doesn’t publish the PE for the ASX (FTSE All-Share), but it does publish it for the T1X, UKX (FTSE 100) and MCX (FTSE 250). The UKX and MCX are valued nearly identically, so I will use the UKX as a proxy for the whole market.

On that basis, the UKX has a trailing PE of 18.3, and a forward PE of 15.5. The T1X has a trailing PE of 24.4, and a forward PE of 17.6. The LIX has a trailing PE of 19.6, and a forward PE of 15.8.

If I just look at the trailing PEs, the T1X relative to the UKX is 1.3 (=24.4/18.3). The LIX relative to the UKX is 1.07. I don’t know exactly how Stockopedia derives their values, and non-robust statistical
measures may be being used.

However, let me take those figures at face values. Lynch’s book, “Beating the Street” provides an interesting graph of the New Horizons Fund vs S&P500 on p 66 as a way of guaging the  relative attractiveness of growth versus the market. A ratio less than 1.2 implies that growth is extremely underpriced, whilst above 2.0 it is extremely overpriced.

Look at the LIX/UKX implies that growth is actually highly attractive at the moment, and that investors should concentrate on growth shares. The T1X/UKX shows a similar story, implying that growth shares offer very good value (as opposed to near-historical lows in the case of the LIX).

It is also worth noting that the HIX (remember, we’re using that as a proxy for value shares), is very near overbought levels. As is the UKX.

So, the surprising conclusion is that growth still offers very good value; and that value and large-cap shares will be prone to a pull-back in the short term.

I doubt that many people will agree with that view, though.