Growth stocks are expected to outperform, but good luck figuring out what they are.

    Want a growth stock for your portfolio? Check out General Electric. Want to diversify by adding a value stock? Try GE. Confused? The lines between growth and value investing have blurred in recent years, muddying the picture regarding the two investment styles and causing some people to question whether asset allocation based on those criteria makes sense anymore.

Things seemed much less ambiguous during the late-'90s tech bubble, when sexy high-growth fare such as software, Internet, telecom and pharmaceutical companies provided stark contrast to fuddy-duddy value sectors such as energy, utilities and materials. But the post-bubble world battered many former growth darlings and made the collective group fairly inexpensive, by historical standards, relative to value stocks.

Many high-fliers lost so much value and got so cheap that they've been reclassified as value stocks. On the flip side, booming oil prices recast energy companies from turtles into hares and sparked debate about whether they should be classified as growth stocks even though they traded at only about ten times earnings. "It's not clear who or what is a growth stock now," says Brian Gendreau, an investment strategist at ING Investment Management. "Valuation isn't always an easy way to differentiate between growth and value."

Even the folks at Morningstar, proponents of the style-box investing tool, don't know what to make of the growth versus value conundrum. "I don't think they (growth and value designations) are outdated," says analyst John Coumarianos. "But we are at an unusual moment because growth can be cyclical and at times like this can become value-oriented."

One thing is clear: Value indexes have been on a roll since the market tanked in 2000. As of year-end 2006, the large-cap Russell 1000 value index posted a seven-year annualized gain of 7.8% versus a loss of 4.9% for the Russell 1000 growth index, while the small-cap Russell 2000 value index's annualized return of 16.2% skunked the 0.23% loss suffered by the Russell 2000 growth index during the same period. Many market watchers believe the worm will turn and that growth stocks-whatever form that takes-will outperform in 2007.

That same argument was made the past two years, and prognosticators could be wrong again this year. But results from Russell Investment Group's quarterly survey of equity and fixed-income money managers conducted last December found some of the most bullish sentiment for growth stocks in the survey's history. In particular, the money managers saw a slowing economy, decelerating earnings, and increasing credit risks as favorable to large-cap growth.

"Growth tends to outperform in the late stages of an expansion and value outperforms in the early stages," says Gendreau. "There's a saying that when growth becomes scarce, people are willing to pay more for it."

Fears of a slowing economy might be behind growth's outperformance in early 2007. As of February 28, the Russell 1000 growth index returned 0.64% versus a 0.30% drop in the value index. The Russell 2000 growth index was up 1.54%, compared with a 0.25% increase for the value index.

In simplest terms, growth investors pay premiums for companies they think will grow faster in the future; value investors like out-of-favor companies with more modest growth prospects that sell at perceived bargains. Either way, the goal is the same (price appreciation) while the risks are the same (no appreciation, or worse).

"I've never met an investor who doesn't want a stock they own to grow," says Phil Edwards, Standard & Poor's managing director of portfolio services. "In that sense, growth versus value doesn't matter." But he believes it matters from a diversification standpoint because growth will eventually outperform value, and investors need to be on both sides of the equation. "I'd make a distinction between investing style and characteristics of a stock," he adds.

Edwards mentioned a recent discussion he had with a growth manager whose fund portfolio was 40% comprised of financials, a traditional value sector that the manager nonetheless saw as a place with good growth opportunities. "That highlights the difference between investing in a specific style and investing in companies with depressed prices that might have upside potential," says Edwards.

Thornburg Core Growth fund manager Alex Motola doesn't worry about the semantics of investing styles. He looks for companies with top-line growth exceeding GDP growth or that has a clear path to get there, and feels his bottom-up approach simplifies his investing process. "We're just trying to find the best investments," he says. "I think it's ludicrous for investors to constrain themselves by cap range or growth versus value considerations."

The fund has profited nicely from Las Vegas Sands and Google, and Motola sees upside in both companies despite their huge run-ups. He says that casino operator Las Vegas Sands has an interest in seven of the ten top properties being built on the strip in Macau, the Chinese enclave that passed Las Vegas in gambling revenue in 2006. It also has a strong presence in Singapore.

In early March, Las Vegas Sands traded roughly 50 times estimated 2007 earnings. But Motola wasn't deterred by the valuation because he believes the company's story is about long-term cash flow. Similarly, he's not worried about Google's stratospheric stock price, particularly given the company's track record of blowing away consensus earnings forecasts and its aggressive forays into various media. "We're looking at higher earnings growth than most people expect," he explains, "and that means a lower multiple on a forward-looking basis."

Google is a throwback to the good old days of late-1990s growth investing, when high-octane tech companies seemingly had boundless futures and people willingly paid hefty premiums to own them. In early March, Google shares traded north of $440 and sold at roughly 39 times estimated 2007 earnings, or more than double the multiple on the S&P 500 and about 50% greater than the multiple on the S&P tech index. Motola and others argue that the company is reasonably priced based on its past phenomenal growth and its long-term potential.

Market analysis firms Standard & Poor's and Russell both recognize that there are different shades of growth, and they try to account for that when assigning stocks to their respective indexes. For instance, Russell employs a method that looks at relative price-to-book ratio and I/B/E/S long-term growth forecasts to gauge a stock's growth and value characteristics (treating different cap sizes separately to avoid distorting relative valuations). It combines the two measures into a composite ranking that's the basis for assigning growth and value weights to each stock. Stocks at opposite ends of the scale are considered more or less pure growth or value, and those in between incorporate both features and are weighted proportionately in the growth and value indexes.

"Many money managers are flexible and go in and out of the soft middle ground," says Lori Richards, client service director of the Russell indexes. "Holding managers to strict growth or value measures creates high turnover and leads to missed opportunities found in the middle ground."

General Electric might be the poster child for that middle ground. In 2003 the company's robust long-term growth forecast and relatively high price-to-book valuation placed it 100% in the Russell 1000 growth index. These days, GE's growth and value weightings within the Russell system are at 50/50 due to lower growth expectations and valuation.

T. Rowe Price Growth Stock fund manager Bob Smith owns tweener companies GE, Microsoft and American International Group because he thinks they'll grow faster than the market even as value managers like them because they're relatively cheap. Smith believes growth stocks have disappointed during the past couple of years because their performance was drowned out by the market's overall strength. "I would've thought a company growing earnings by 12% to 14% would be considered good," he says, "but in reality it's just average. We missed that, and I think it's a timing issue."

Going forward, Smith likes the health-care services sector and such companies as UnitedHealth Group, Caremark RX and WellPoint. He also has sizeable international exposure through the likes of GE, global banker UBS, Canadian telecom giant Rogers Communications and Indian telecom company Bharti Airtel. He thinks that materials and energy are good long-term plays that'll probably underperform in 2007.

John Massey, portfolio manager of the SunAmerica Blue Chip Growth fund, has technology stakes ranging from high P/E companies Google and Yahoo to more bargain-oriented plays Motorola and IBM. He also likes eBay. "It's inexpensive not so much on fundamentals but because it's a huge cash generator," he says. One of Massey's largest holdings is Procter & Gamble, a company that could benefit from international exposure and the integration of its Gillette acquisition.

This is a strange investing environment, partly due to the schizo investing period that preceded it. The market's "worst" year between 1995 through 1999 was a 21% gain, followed by a bear market that included the worst 36-month stretch since the Great Depression. Recently, formerly boring commodities have been on fire. "Macroeconomic and capital markets data are blunt instruments designed for strategic long-term moves," says Russell portfolio strategist Stephen Wood.    

He likens the current winning streak in value stocks to a bowstring getting pulled ever tighter before it snaps back. Wood doesn't advocate aggressive asset allocation, but he thinks it's probably a good time to rebalance across different asset classes. With growth, that means quality companies with consistent earnings that can defend their profits in a downshifting economy.