Use this simple investing strategy to get the most out of growth stocks and value investing
I don’t normally recommend stock-picking and trying to beat the market on the blog. It’s the relentless chasing of returns that ends up losing your money and costs a mountain of fees.
I do like following the higher-level strategies, investing in themes that have the power of the major economic forces behind them or those that make intuitive sense. It’s through this smart positioning that investors can beat their investing goals and achieve those higher returns…all with less time spent analyzing stocks.
Two of the most popular themes in investing are growth stocks and value investing. These two strategies are at polar opposites on fundamental factors and usually attract two different types of investors.
But there’s good reason to look at both growth and value stocks. In fact, I’ve found a strategy that can give you the best of both worlds – safety and higher returns.
The Debate of Growth vs Value Investing
The debate between growth vs value stocks is one of the oldest among investors. Both strategies make intuitive sense and both have outperformed for periods of time.
For a long time, value investing seemed to have the upper-hand. Nobel Laureates Fama and French were made famous by finding the ‘value premium’ and proving mathematically that value stocks beat growth investing.
After all, who doesn’t like paying less for something. The very definition of value investing is stocks with lower relative price-to-earnings ratios. You are paying less for a share in the company’s earnings.
Value stocks typically offer higher dividends as well and are in more mature industries. This is almost by definition. Companies in mature industries like consumer staples and utilities have fewer growth opportunities so they can share cash flow with investors through dividends rather than plow it all back into projects.
But growth is why you’re investing. Stock investing is essentially a bet on future earnings, future growth of a company. Why not invest in companies that are growing fastest?
Shares of growth companies may not pay out the dividend you get from a value stock but you can create your own dividend by selling a few shares. Growth stocks aren’t necessarily highly-volatile and high-risk either.
Facebook (Nasdaq: FB) is considered a growth stock, growing earnings at over 10% a year but few investors would call the world’s largest social platform a risky bet. Shares may be relatively expensive at 35-times earnings but that didn’t stop them from providing a 50% return last year.
Value stocks, as measured by the Russell 1000 Index, outperformed growth stocks for much of the 28 years to the 2008 stock market crash. This is the ‘value premium’ everyone had come to rely on. Shares of value stocks were said to be more dependable and less volatile, with a steady return on which investors could rely.
Something happened to the value premium after the recession and growth stocks have outperformed since.
Much of the outperformance in growth stocks can be attributed to historically-low interest rates brought on by the Federal Reserve and other central banks. The Fed dropped interest rates to near-zero in an effort to jumpstart the economy after the housing bubble burst.
That meant cheap debt financing for companies that could be used to fund growth projects and buyback shares of stock. That has favored growth companies while value companies have languished.
It doesn’t mean that growth stocks will outperform forever. There are good arguments to invest in both strategies.
So what’s the best strategy, value or growth?
…or both?
How to Have Your Growth Stocks and Your Value Investing Too
There is a way you can invest in both value and growth stocks, and you can do it strategically to get the highest returns possible.
I’m not talking about buying the entire market so you get a mix of value and growth all the time. I’m talking about strategically shifting your investment dollars from value to growth to take advantage of each.
Think about when each strategy, growth vs value, should outperform:
- Shares of value stocks do better during times of higher uncertainty and higher interest rates. Value stocks do not fall as much in a stock market crash because the companies are in mature industries with established players.
- Shares of growth stocks do better when the economy is growing quickly, when interest rates are lower and when investor sentiment is increasing. Everything is pointing up and investors are willing to make riskier bets on fast-growing companies.
This lends itself to a simple strategy of buying growth stocks after the market has crashed and for several years into a recovery, then shifting to value stocks as interest rates rise and the economic cycle ages.
Growth stocks will have sold off sharply in an economic recession because investors stampede for the exits on anything with a little risk. Central bankers lower interest rates to jumpstart the economy, making it cheaper for shares of growth companies to invest in projects.
As the economy recovers, interest rates rise and weigh on the debt financing used by growth companies. Eventually, investors start to question the high prices for growth stocks and how long the economy can grow before another recession. This is when it makes sense to shift your investment dollars to the safety of value stocks.
By shifting to value stocks, you still get the opportunity for high returns but you also get the safety of mature companies. The consumer staples ETF (XLP) produced a 9.5% return in 2017, a solid return even though it underperformed some growth sectors.
If the bull market continues for another year or two, value stocks may outperform on investor worries and higher rates.
Of course, you can never hope to time the market perfectly, but you don’t have to either.
The growth-and-value strategy is a good fit for long-term investors. You’re really not trying to time the market because you’re not selling your stocks, just shifting to buying a different group.
If you shift to buying value stocks late in the bull market, by the time a bear market comes, your portfolio will have a larger weight in relatively safe, value names. Earnings at growth companies will have continued to grow and share prices may not drop much below where you bought them for several years prior.
It’s a great strategy to keep investing while limiting your losses when stocks tumble.
You don’t have to choose growth stocks versus value investing. A simple strategy of shifting means you can take advantage of higher returns in growth stocks when they are outperforming as well as seeking the safety of value stocks later in the cycle. This strategy should not only limit losses in a stock market crash but also offer the highest return possible.
