Benjamin Graham and Warren Buffet both gained fame and fortune from a strict adherence to value investing. Both professional and beginning investors have followed in their footsteps for generations. Now, some experienced investors are questioning this strategy, and many beginning investors have abandoned it completely in favor of a growth stock strategy. (For more, see: Value Investing: Famous Value Investors.)
What Caused the Transition From Value to Growth?
Value investing is firmly rooted in the theory that buying low and selling high is the way to make money in the stock market. Financially, it makes sense: psychologically, it's satisfying. Who doesn’t love a bargain? However, after literally decades of delivering predictable results, value stocks have declined over the past few years. The Russell 1000 Growth Index and Russell 1000 Value Index can be used as proxies to classify and track the performance of the 1,000 largest companies in the U.S. equity market. The results are clear: A growth stock strategy outperforms a value investing strategy. The trend of growth over value has even accelerated recently, widening the performance gap. As a result, investors have done what they always do: sell the losers and chase the winners. (For more, see: Value Investing: What is Value Investing?)
Growth Beats Value
What’s Driving the Growth Trend?
What’s driving the outperformance of growth stocks? Much of the performance gap can be attributed to technology companies. Investors have fallen in love with Facebook (FB), Apple (AAPL), Amazon (AMZN), Netflix (NFLX) and Google (GOOG). Collectively referred to as FAANG stocks, these companies have become wildly held as a result of their popular technology and history of innovation. They are also currently responsible for a lion’s share of the recent stock market returns. Because of this, they've become wildly expensive, trading at price-to-earnings ratios that are the exact opposite of what a value investor would view as a good deal. As a result, professional value investors have generally shied away from these names, as well as other popular, but unprofitable or minimally profitable companies like Tesla (TSLA) and Snap (SNAP).
Growth investors, on the other hand, have been buying shares in these companies regardless of price or profits. From their perspective, these companies have good ideas and promising futures. If they continue to be successful (and in their mind, there’s no reason to believe they won’t be), their prices will only go up from here. Buying them today, at any price, will seem like a bargain a few years from now. Their ever-climbing share prices have, so far, supported this line of thinking.
Is Value Investing Dead?
When a long-term trend reverses itself, people try to reach for a conclusion that demonstrates that something fundamental has changed, and that “things are different this time.” When it comes to growth versus value investing, growth proponents are arguing that corporate profitability has risen above its long-term trend, and will remain there as a result of a combination of technological innovation and tax cuts.
Value investors argue that strong performance by growth stocks is typical at the tail end of a bull market. They claim that the only thing different this time is that the bull market has run for a notably long period of time, and so has propped up artificially low interest rates.
A review of longer-term historical performance suggests that it may be too early to pass final judgment on value investing. Looking at the Russell 1000 Growth and Value indices since their inception in 2002 shows that value has actually outperformed growth at most points in the history of these indices.
Value Beats Growth
How Should You Communicate With Clients?
With so many news stories touting the large sums of money being made in tech stocks, it's inevitable that some investors will want to jump on the band wagon. Some investors may even be willing to disregard well-constructed investment plans in pursuit of these short-term gains. If this describes one of your clients, it's important to remind them of the merits of diversification as a logical course of action. All investors want to make money, but proper diversification strategies have demonstrated the importance of not putting all your proverbial eggs into one basket.
At this stage, a strong focus on client education is recommended in order to help put the current situation in perspective. This can include a discussion about current market conditions, with an emphasis on the fact that nothing lasts forever – good market conditions or bad market conditions. Your conversation could also include references to the slim odds of perfectly calling the top of a rising market, the perils of market timing, and presenting prudent planning as a sound strategy for investing, regardless of market conditions.
The Bottom Line
If you are finding that a particular client is resistant to advice about how to balance a short-term, growth stock strategy with a long-term, value investing strategy, one approach you could take is to minimize their exposure. Instead of using every penny in their portfolio to pursue last-year’s winners, they could designate a subset of their portfolio to growth stocks. This is one way to maintain an overall balance. If this approach isn't effective, you might consider having a frank discussion with your clients about the value of professional advice.
As a client in a client-advisor relationship, sometimes this means recognizing the wisdom of seasoned professionals and acting on it even when you would prefer to take another course of action. If all else fails, the lessons you've learned from previous market downturns are a great way illustrate that good market conditions never last forever. Regardless of how your clients respond to your advice, you are there to help, and you can assure your clients that you will continue to provide sound advice both now and in the future, even if they don’t always act on it.