After being overshadowed by growth investing in recent years, value stock investing gained popularity in 2021 as wary investors sought refuge from the stock market volatility caused by the global pandemic. Known for their relatively low valuations but generating high dividend yields, value stocks are often seen as a safe bet by some investors. After the dot-com bubble burst in 2000, value stock prices outperformed growth by 16% over the next five years.
Value stocks will likely outperform growth stocks over the next 10 years by 5% to 7% and “perhaps by an even wider margin over the next five years,” wrote Kevin DiCiurcio, head of the Vanguard Capital Markets Model research team in an April report.
“And as our recent research shows, the coming reversal of fortunes would restore the decades-long performance edge that academic researchers have ascribed to value stocks,” he wrote. Growth stock prices are not likely to continue to outperform and are overdone, DiCiurcio argues.
If you’re considering adopting the mindset of value investors such as Warren Buffett, here’s what you should keep in mind: Value stocks favor rising interest rate environments.
Take caution when adding value stocks.
Returns of value stocks.
How inflation affects value stocks.
Value stocks are usually more established but undervalued companies and tend to take a rising rate environment in stride, says Mike Loewengart, managing director of investment strategy at E-Trade Financial, an Arlington, Virginia-based brokerage.
“One of the main draws of value stocks is the opportunity for consistent dividends , but income isn’t necessarily guaranteed,” he says. “Since the pandemic-driven economic recovery began, the growth versus value debate has been front and center with value making quite the comeback at the beginning and growth names taking hold later as the rebound slowed.”
In low interest rate environments, growth stocks are often viewed favorably since it is easier for companies to grow their sales and profit margins. Companies also have access to cheaper capital, which could lead to more digital innovation, and stocks in the tech industry often benefit, Loewengart says.
In an environment with rising interest rates, it can be challenging for growth companies to outperform or even meet earnings expectations. Companies that fall in the growth bucket also typically reinvest any cash on hand, so the chances of a dividend payout are lower.
“While the debate tends to make headlines, the eye is really in the beholder when it comes to value versus growth,” he says. “An investor can see a growth opportunity in an underappreciated stock which could be considered for all intents and purposes a value stock.”
If you’re worried about inflation and plan on moving to value stocks, it’s worth considering whether that investment strategy is going to make your portfolio lopsided. Since many equities owned in most portfolios are already diversified and the large-cap allocation is in a market-cap weighted index product that is passive, adding an allocation to value could mean adding more of the same stocks, says Jodie Gunzberg, managing director of CoinDesk Indexes at TradeBlock, a Stamford, Connecticut-based cryptocurrency company.
“Even worse is that most value indexes are market-cap weighted so the size overpowers the style, leading to greater risk from increased exposure to the big stocks,” she says.
Using 20 years of monthly data, the correlation between the S&P 500 and the S&P 500 Value indexes is almost perfect, she says.
“The correlation is near 1, and that means the change in the value of the S&P 500 is exactly proportional to the change in the value of the S&P 500 Value,” Gunzberg says.
You should also think about your time horizon: Value stocks outperform growth stocks over longer periods, making them a critical component of retirement portfolios .
“Over the very long term, value outperforms growth by a substantial margin,” says Robert Johnson, a finance professor at Creighton University.
Data from 1927 through 2020 demonstrates that small value stocks had a return of 14.3% annually, and large value stocks had a return of 11.8% annually, he says. During the same period, large growth stocks had a return of 10%, and small growth stocks had a return of 9.3%.Growth stocks have outperformed value stocks substantially during some periods such as the decade beginning in 2010, Johnson says. Large growth stocks returned on average 15.2% annually and small growth stocks returned 12.5%, while large value stocks returned 11.2% and small value stocks returned 10.8%.”An impatient investor might want to avoid value stocks during some periods of time,” he says. “Value stocks are more conservatively priced and generally don’t suffer as much when fundamentals or market […]
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