Page 13 - ISQ UK_October 2017

OCTOBER 2018

Two Sides of the Coin: Value & Growth

VALUE STOCKS GROWTH STOCKS
These companies are often priced based As their name suggests, these
on their current value companies often reinvest their earnings into future
and distribute a larger portion of current growth opportunities.
earnings to shareholders.

opportunities overall. Consequently, investors bond proxies appears to have fallen more than
have piled into stocks with greater earnings growth As interest rates rise, they demand for the high earnings growers. A stock
potential that can better justify the higher valuations. erode the present value of with a 2-3% dividend that is not expected to grow
Value tends to lead as recessions near, as investors future earnings, whereas at a high rate simply becomes less attractive as
sell their high-flying growth stocks and move into when interest rates fall, they more competitive yields can be found in fixed
more stable companies, and when coming out of a increase the present value of income. A stock with the potential to grow
market downturn, when beaten-down stocks have future earnings. earnings at a high rate is not as affected by rising
more room to rise. As a result, it should not come as rates while they are still considered to be at low
a complete surprise that, since 2006, the periods levels overall.
when value has been the better performer have mostly come after
meaningful sell-offs in the broad market. We think these sell-offs PASSIVE VS. ACTIVE INVESTING
help create more value opportunities when they occur, and relative The massive shift to passive investing benefits growth stocks at the
performance improves while those beaten-down companies return expense of value stocks. Historically, active investors and portfolio
to fair valuations. Therefore, it may require more of a significant managers have generally favored value investing strategies.
decline in the broad market to put the wind at the backs of value However, as more money flows into products that ‘buy the market’
stocks again. or ‘buy a sector,’ value is largely being thrown out the window.
Instead, stocks that are bid up to higher valuations rise in market
INTEREST RATES AND EARNINGS GROWTH capitalization and become even larger holdings within these funds,
Interest rates have been near historical lows for the last several years. while stocks that fall become smaller holdings. In other words,
Lower interest rates translate to a lower discount rate when valuing there’s a built-in momentum factor that doesn’t exactly help stocks
future earnings, which means future earnings are worth more when that are ‘undervalued.’ It’s probably not a huge coincidence that
discounted back to the present. Relatedly, with interest rates and the clear outperformance of growth over value going back to 2006
economic growth as low as they have been over the past few years, has occurred at the same time passive investing and index funds
many investors have been reaching for returns in equity investments have proliferated.
to make up for the lackluster yields in fixed income. A ‘barbell-type’
strategy has been quite common for investors, as they balance less TRADING: COST AND EFFICIENCY
volatile, low-yielding bonds with stocks that have potential for capital On a closely-related note, it used to be more costly and time-
gains. As rates rose over the last couple of years, demand for the consuming to research and trade stocks, and it was near impossible
lower growth, higher dividend-yielding stocks commonly used as for the average investor to try to duplicate an index or even to hold

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