Growth vs value:
What they mean and why it matters

Investment style is key concept for those new to wealth management to get to grips with. In particular, the terms “growth” and “value” are extremely prevalent in the industry. James Leeming, of Smith & Williamson, explains investment style, why the terms ‘growth’ and ‘value’ are especially important and why this all matters for investors.

The global equity market is vast and the number of stocks that can be purchased almost limitless. So how do investors decide which stocks to buy and when? By grouping stocks with certain common characteristics, investors are able to categorise the enormous global opportunity set into various investment “styles”.

Understanding styles and figuring out which style works best at what time is a difficult art. There are a range of investment styles including defensives, momentum and quality. Importantly, these terms are not mutually exclusive, and stocks can display aspects of several styles. Yet, growth and value are the two broadest and most frequently referenced, so let’s investigate these further.

Growth investing

Looking first at growth, this is an investment strategy that aims to identify stocks where profits are growing quickly and are expected to continue to grow in the future. Growth investors believe that the most important factor driving stock returns is the underlying growth of that company’s profits.
Growing profits are a virtuous cycle when used to fund further development for a business
Microsoft is a good example. From 2019 to 2020, Microsoft grew its profits by 23%i. Looking forward, market experts believe this growth will continue, with consensus expectations forecasting 28% growth in 2021ii. The strength and consistency of its growth has delivered great returns for investors. Growing profits also compound over time: they can be reinvested in the business and help to drive further success. Consider how Microsoft profits from its core Office products and how this helped to fund the development of its cloud computing division, Azure, or Microsoft Teams. Growing profits are a virtuous cycle when used to fund further development for a business.

Value investing

Turning our attention to value, this is an investment strategy that aims to identify stocks trading below their estimated “fair value” and then profit as the share price adjusts. Once the shares achieve their target valuation, investors will typically then rotate into new bargains.

Value investors undertake a vast amount of primary research, look at company accounts, and meet company management all with the purpose of deriving their own “fair value” for the company.

Value investors undertake a vast amount of primary research, look at company accounts, and meet company management all with the purpose of deriving their own “fair value” for the company

While any stock can be a value company, a good example at the moment would be the banking sector. An estimate of fair value can be made by looking at the bank’s net assets (assets minus liabilities), using readily available public information.

For example, currently NatWest Group is trading at roughly half of its net asset value and might therefore be considered “cheap” and worthy of investment for a value investor. In general, value investors will be looking at those parts of the market that are unfashionable and out of favour.

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Top Tip

The past ten years have been all about growth investing, but many are now advocating a shift to a value focus as inflation rears its head once more. Now is the time to check that your portfolio is positioned effectively for the investment environment we find ourselves in – and how things are likely to unfold in coming years. Why not let us set up some discussions with experts fast and free so you can check your strategy is still fit for purpose?

Lee Goggin - Co-Founder

Lee Goggin

Co-Founder

Which is best?

Growth investing works well if the company continues to meet or exceed its growth targets. However, if a company is forecast to grow at 15% and it only delivers 10%, though still a positive absolute number, this can be bad news for the stock price!

Value investing works well if other investors start to spot the same bargain that you have and begin buying shares, driving the price up. However, value investing often requires patience and the emergence of a catalyst – something that will generate interest in the stock and bring new investors to the stock.

The truth is neither style is inherently better, both have their proponents with many illustrious investors on both sides of the debate

The truth is neither style is inherently better, both have their proponents with many illustrious investors on both sides of the debate.

Why does this matter to me?

Crucially though, one style is often more prevalent in markets and that can make a difference to returns. The last decade or so has been a paradise for growth investors. This is shown as the MSCI Growth Index has returned 234% from 10 year to the end of 2021, while the MSCI Value Index has returned only 92% in the same periodiii.
Rates remains low today and low rates are generally thought to favour growth investing as future profit growth is discounted at a lower rate, meaning future profits are worth more
This performance divergence has been driven by the prevalence of very low interest rates and ultra-accommodative monetary policy. As the financial system emerged from under the cloud of the global financial crash in 2008/09, central banks across the globe unveiled new policy tools, such as quantitative easing, to stimulate the economy and meet their target inflation rates. Rates remains low today and low rates are generally thought to favour growth investing as future profit growth is discounted at a lower rate, meaning future profits are worth more.

Which style will be favourable going forward?

While it has been the right call to invest in growth for the last decade, at some point the rules of the game might change. One of the biggest threats to growth stocks is the emergence of inflation, which might lead interest rates higher favouring value stocks, such as energy and mining companies. Indeed, the major topic in investment markets in 2021 has been the return of inflation, as the global economy rebounds from the pandemic. The US saw CPI inflation in April of 4.2%iv and value stocks have begun to outperform growth stocks so far this year for this very reason.
We believe changing market conditions favour active managers, who can switch between styles dependent on conditions in financial markets
We believe changing market conditions favour active managers, who can switch between styles dependent on conditions in financial markets. The timing of style shifts is difficult to analyse and often seemingly at the whim of the market. Active managers have the scale and depth of resource to best position themselves to invest in the right investment styles at the right time and ultimately improve portfolio performance.
i Thomson Reuters, 10/06/21
ii Ibid
iii Ibid
iv Ibid
Disclaimer

By necessity, this briefing can only provide a short overview and it is essential to seek professional advice before applying the contents of this article. This briefing does not constitute advice nor a recommendation relating to the acquisition or disposal of investments. No responsibility can be taken for any loss arising from action taken or refrained from on the basis of this publication. Details correct at time of writing.

Risk warning

Investment does involve risk. The value of investments and the income from them can go down as well as up. The investor may not receive back, in total, the original amount invested. Past performance is not a guide to future performance. Rates of tax are those prevailing at the time and are subject to change without notice. Clients should always seek appropriate advice from their financial adviser before committing funds for investment. When investments are made in overseas securities, movements in exchange rates may have an effect on the value of that investment. The effect may be favourable or unfavourable.

Smith & Williamson Investment Management LLP Authorised and regulated by the Financial Conduct Authority. Tilney Smith & Williamson Limited 2021.

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