Striking the Balance: Growth vs. Value Stocks in Today's Market

Kotak Insights | Date 27/07/2024

“The excessive increase of anything causes a reaction in the opposite direction.”

The Greek philosopher Plato was right on the mark when he made the statement above.

In 2022, value stocks made a strong comeback and outperformed their growth counterparts.

As the low interest rate and easy money policy era ended, growth stocks found very few takers and value stocks, which had been underperforming for years, made hay while the sun was still shining.

Cash flows for growth stocks are far out in the future than those for value stocks. So, a higher interest rate denominator lowers the value of growth stocks more than it does for value stocks.

Skip forward two years to 2024, and an excess of value stocks has given rise to growth stocks.

The situation is so extreme now that even value investors are guzzling their heads over the astronomical rise in growth stocks.

The question is – which is the perfect fit for you, growth stocks or value stocks?

Before we get to that, let’s review the basics and what growth and value stocks are.

Value Stocks vs Growth Stocks

Value stocks are those stocks trading below their fair market value. These companies offer regular dividends to shareholders.

This style of investing is based on the simple premise that you can win long-term by investing in an asset at a lower price than its intrinsic value.

Growth stocks, on the other hand, present investors with a high profit potential as their share price rises rapidly.

Growth stocks usually outperform their peers and the industry, justifying the premium valuations they command.

What the Past Says About Growth vs Value Stocks

Historically, value and growth stocks tend to outperform each other alternatively.

However, after the global financial crisis of 2007, the Fed maintained an unusually low interest rate, favouring growth stocks for several years.

Near zero interest rates allowed investors to take longer-duration equity risks.

In the US market, growth stocks are currently valued at one of their highest levels compared to their value counterparts.

In India, the valuation of benchmarks is not as expensive and is a tad above the long-term average.

So, if you believe in mean reversion, the golden age of investing in growth stocks is almost over.

In the past, value investing has outperformed the market over longer periods of time. The only catch is that there would be significant periods in which you will also underperform the market.

No wonder investors are falling head over heels towards growth stocks these days… it could be because of the lottery mentality. If people happen to own a hot solar stock or a chipmaker like Nvidia that’s up 218% in a year, they won’t shy away from expressing their enthusiasm. Then, these stocks tend to dominate headlines and take up investors' minds. This feedback loop forces other investors into the same stock regardless of its current valuation.

Growth or Value - Which is the Better Fit for You?

Both value and growth are inseparable elements in successful investing.

We've observed instances where companies' book values diminish over time due to inherently flawed business models. Regardless of discounted prices, investing in these companies often results in value traps.

Relying solely on price-to-book value ratios or historical growth rates is insufficient for selecting stocks that yield good returns. The key lies in thoroughly understanding the businesses you invest in.

Historical growth figures aren't enough for growth stocks. You must be confident that future growth is sustainable and driven by high returns on invested capital.

For example, do you like buying stocks after a correction only to sell them when they bounce back? If so, then value investing may suit you.

Or do you like to study companies to find out how much they can grow? In that case, you may like the idea of growth investing.

If you're not typically a growth investor, consider reconsidering before switching from value to growth.

Why are you interested in becoming a growth investor? Are your current returns unsatisfactory?

For instance, assess your returns from value investing. You might find they are sufficient and may not need to introduce additional risk to your portfolio by purchasing growth stocks.

Remember, growth stocks often have high investor expectations, so they trade at elevated valuations, making them the priciest stocks in the market.

Growth stocks can plummet if these expectations aren't met due to disappointing quarterly results or unforeseen events.

Ultimately, it all comes down to whether or not you believe the markets are efficient. If you do, then you can consider sticking to the index-investing route. If not, value investing is among the strongest contenders for beating the market.

That’s it for today; we hope this article opened your mind to both investing styles.

Please let us know in the comments section below whether the coming decade will favour growth or value stocks.

Happy Investing!

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Sources and References: GOOGLE

Disclaimer: This article is for informational purposes only and does not constitute financial advice. It is not produced by the desk of the Kotak Securities Research Team, nor is it a report published by the Kotak Securities Research Team. The information presented is compiled from several secondary sources available on the internet and may change over time. Investors should conduct their own research and consult with financial professionals before making any investment decisions. Read the full disclaimer here.

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