Aligning your portfolio with growth or value equities is a common investing approach, but few investors understand the key differences between these categories. Fisher Investments Canada believes a well-diversified portfolio should have elements of both. However, understanding when to emphasize growth or value equities can help your portfolio performance over time. To help you determine which may be best for your personal portfolio, following is a summary of each.
What are the basic characteristics of value equities?
Valuation metrics are one way to distinguish growth vs. value equities. Common valuation metrics used by investors include price-to-earnings (P/E), price-to-sales (P/S) and price-to book (P/B) ratios, among others.
Generally, value equities often carry lower valuation metrics than growth companies. As the name implies, investors believe “value” equities trade at valuations below their fair value. From an operational perspective, value companies tend to invest less in long-term opportunities and return more of their profits to shareholders in the form of dividends and equity buybacks. They are also generally more economically sensitive and rely heavily on bank financing.
The best time to own value equities is when economic growth is accelerating – particularly in early-stage market cycles. Conversely, value equities can face headwinds when economic growth decelerates or contracts. In a bear market – an equity market decline of greater than 20 per cent – value equities get disproportionately hurt because banks tighten lending standards and investors fear their ability to pay debt obligations during a period of declining sales.
Investor sentiment eventually becomes overly pessimistic and many value companies are able to weather the economic hardships thanks to cost-cutting measures. This creates a gap between reality and expectations – what Fisher Investments Canada believes is a key driver of equity prices – which propels value equities to outperform as a new bull market begins.
What are the basic characteristics of growth equities?
Companies in this category tend to have growth rates that exceed broader economy – hence, growth. Growth companies’ characteristics are opposite to value in many ways. They tend to trade at higher valuation metrics, reinvest their profits for the future rather than paying out dividends, have lower debt levels and are less sensitive to economic conditions. Increased profitability potential is another key differentiator. This could be due to specific industry drivers – if the industry is growing rapidly, it can often support multiple companies without becoming saturated.
Historically, growth outperforms value equities later in economic cycles when the economy is slowing down or maturing. Investors reward highly profitable companies that are more insulated against faltering economic conditions. Growth equities can outperform for long stretches before a bear market, but are also attractive in a downturn due to their low debt levels.
How do sectors and geography come into play?
Growth and value equities tend to cluster in different sectors and geographic regions. For example, information technology, communication services and consumer discretionary sectors all have a heavy concentration of growth equities. Industrials, energy, materials and financials tend to be value-oriented. However, an equity is not necessarily a growth equity just because it is in a growth sector. There are many exceptions to the rule. For example, Nokia is a value company but resides in the technology sector.
This is also true of geographical exposure. The United States is home to most of the world’s large information technology companies. As a result, growth equities heavily influence U.S. equity performance. In contrast, the United Kingdom has high exposure to the financials, energy and healthcare sectors. Its performance is closely linked to value equities.
However, there are plenty of value equities in the U.S. and growth equities in the U.K. You have to look at each companies’ individual attributes such as market share, valuation metrics, profitability, sales expectations, dividend policies, industry participants, etc. in order to truly understand whether a company is growth or value.
Is growth or value better?
Fisher Investments Canada does not believe growth or value is inherently superior. There are appropriate times to hold more of one than the other, but you should maintain a balanced exposure. No one style will remain in favor forever. Understanding where you are in the market cycle can help guide when to emphasize growth or value, but the timing is very difficult to get right and can be influenced by a variety of factors.
There are times when historical trends don’t hold true. Growth and value categories can be influenced by unique factors associated with each market cycle. Following the 2008 global financial crisis, financial equities – a value category – faced headwinds early in the new market cycle as investors shied away from companies facing increased scrutiny and regulatory headwinds.
A recent example is the bear market in 2020 driven by lockdowns amid the ongoing COVID crisis. History would typically suggest a period of value outperformance once the market began to recover. However, growth outperformed as information technology firms benefitted from a world in need of advanced digital solutions. To avoid over concentrating on growth or value, Fisher Investments Canada believes you should construct a well-diversified portfolio suited for your long-term objectives, inclusive of both categories.
Fisher Asset Management, LLC does business under this name in Ontario and Newfoundland & Labrador. In all other provinces, Fisher Asset Management, LLC does business as Fisher Investments Canada and as Fisher Investments.
Investing in stock markets involves the risk of loss and there is no guarantee that all or any capital invested will be repaid. Past performance is no guarantee of future returns. International currency fluctuations may result in a higher or lower investment return. This document constitutes the general views of Fisher Investments Canada and should not be regarded as personalized investment or tax advice or as a representation of its performance or that of its clients. No assurances are made that Fisher Investments Canada will continue to hold these views, which may change at any time based on new information, analysis or reconsideration. In addition, no assurances are made regarding the accuracy of any forecast made herein. Not all past forecasts have been, nor future forecasts will be, as accurate as any contained herein.
This content was produced by Fisher Investments Canada. The Globe and Mail was not involved in its creation.