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Some Growth Stocks Now Value Buys

One of the more vocal arguments against value investing stems from a belief that we’re in a “new normal” environment where innovative, or high-tech, companies have a leg up on “old guard” industries, such as energy or financials.

FAANG stocks have typically been the poster children for this position; these behemoth technology companies have contributed meaningfully to the market’s overall return and, by virtue of being growth stocks, the negative value premiums in recent years.

Well, guess who showed up as value this summer? That’s right, Russell Indices reclassified Meta (formerly Facebook, the “F” in FAANG) and Netflix (the “N”) from growth to value during the index provider’s annual reconstitution event. Although signs have been pointing to the waning dominance of FAANG stocks since the start of 2022, it is somewhat ironic that 40% of the pillars supporting an aversion to value investing have now become value stocks themselves.

This also serves to highlight a possible misconception about the spirit of value investing. A value premium is a discount-rate effect: If expected future cash flows are not identically discounted for all stocks, then the ones with low prices relative to their expected future cash flows have higher expected returns. Investors advocating for the superiority of growth firms, such as the FAANGs, are inadvertently making the case for their expected future cash flows to be discounted at a lower level—all else equal, greater certainty around future success should be associated with a lower expected return.

In fact, as Exhibit 1 shows, this is generally what we see for stocks of companies once they grow to become among the largest in the market. In other words, we have to be careful about equating expected company success with expected stock returns. Sometimes “great” companies don’t produce outsized stock performance.

Some Growth Stocks Now Value Buys

Regardless of whether growth outperforms value in the short run, or vice versa, we hold a good mix of both. You never know when they’ll switch sides, and both are prone to long periods of outperformance.

 

Source: Dimensional Fund Advisors

Mike Minter

Mike develops investment portfolio allocations, handles trading and rebalancing, and conducts research and analysis as a Portfolio Manager and Financial Advisor for the firm. As a perpetual student of investing and the markets, Mike considers himself obsessed with the subject. Mike has earned the CERTIFIED FINANCIAL PLANNER™ (CFP®) and Certified Fund Specialist® designations. He is also an active member of the Houston chapter of the Financial Planning Association (FPA).   Read Mike’s Profile HereRead More Articles by Mike

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