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 "I don't think they (growth and value designations) are outdated," says analyst John Coumarianos.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.