Essay: Value Vs Growth Stocks - Performance Metrics Analysis.

Value and Growth Stocks: Accounting Metrics

Risk-averse investors choose growth companies, which are high-risk but potentially higher-returning investments. All of those are stocks of firms that have the potential to develop rapidly and continuously in the foreseeable future (Calandro 2016). Value shares are preferred by long-term investors who are willing to take on less risk and they are limited in quantity and provide long-term investment returns and they are undervalued stocks or firms with a stock market that is much higher than its fair value. The following accounting metrics define value and growth stocks differently:

• Book to market ratio – Value investors look for stocks with high book to market ratio as it indicates that the stock is trading at a comparatively cheaper price than its book value. A book to market ratio of more than 1 indicates that investors are willing to pay more for a company compared to its assets.
• Earnings to price ratio – A high price to earnings indicates that a stock is in demand and investors are willing to pay a higher price for a stock. Hence, stocks with high P/E ratio are associated with growth stocks and vice versa.
• Price to cash flow ratios – A low price to free cash flow ratio indicates a value company, since value equities are those for which investors are ready to pay a lower price per cash flow.
• Dividends to price ratios – Growth stocks do not usually pay dividends as the profits earned by the firms are reinvested back in the business, hence the stocks with a high dividend to price ratios are considered to be value stocks.

Based on the table above, value stocks have provided higher returns over the period of 46 years starting from 1975 to 2021. The average return of value stock portfolio is around 1.33 percent whereas the average return of growth stock portfolio was around 1 percent. 

The table above represents the performance metrics data of portfolio consisting of high and low price to earnings ratio stocks. The growth stocks consisting of high price to earnings ratio stocks earned a return of around 1.38 percent which is more when compared to the returns of 0.97% high earnings to price value stocks. 

High cash flow to price ratio measures the ratio of cash flows generated by a company compared to the low cash flow to price ratio companies. A high P/CF ratio means the company is selling at a steep cost but again not producing enough cash flows to maintain the multiple. The growth portfolio consisting of stocks of high cash flows to price ratio outperformed the value stocks consisting of low high cash flows to price ratio. The standard deviation of the growth portfolio was around 5.23 and the standard deviation of value portfolio is around 5.83 which is higher than the growth portfolio.

Companies which pay high dividends are generally considered to be value companies as the value stocks does not have many active projects hence the savings can be used for the purpose of providing dividends. The company which pays high dividend yields are seemed to have been outperforming the market and the company which does not pays dividend with a dividend yield of zero percent.

After the analysis of the market data it can be concluded that value stocks have outperformed growth stocks in terms of returns and stability of returns as measured by standard deviation. Value stocks have even outperformed the broader market represented by the Australia Market Portfolio data for the year starting from 1975 to 2021. Growth stock have provided returns of around 1 percent for the period analyzed with a standard deviation of 5.56. The Sharpe ratio measures the risk to reward ratio of the portfolio and the value portfolio have given a positive performance with a Sharpe ratio of 0.0408. Growth portfolio have given a negative Sharpe ratio of -0.0218 which means growth portfolio have underperformed the risk-free asset in the economy.

Growth portfolios represented by high earnings to price ratio can be said to have outperformed the market with a return of 1.38 percent compared to a return of 1.12 percent provided by the Australian market portfolio. The value stock portfolio on the other hand provided returns of 0.97% which is less than the growth stock portfolio and the market as a whole. The growth stock portfolio based on higher price to earnings ratio has exhibited lower standard deviation compared to the value stocks. The growth portfolio has provided positive risk-adjusted return with a return of around 0.0545 measured by the Sharpe Ratio. The Sharpe ratio of the portfolio with value stocks was around -0.0259 which depicts the underperformance of the portfolio compared to the risk-free rate.

Value Stocks Performance Over 46 Years

High cash flows to price portfolio represents the growth stock portfolio and according the analysis conducted for the years 1975 to 2021, it can be concluded that the portfolio has outperformed the market portfolio and the risk-free rate of return. Growth portfolio with stocks having high cash flows to price ratio have outperformed the growth portfolio represented by high price to earning ratio and low book to market ratio. The value stock portfolio on the other hand have underperformed the benchmark with an average return of around 0.96%. The standard deviation of the value stock portfolio was around 5.83 and the growth stock portfolio standard deviation was 5.23. The growth stocks portfolio has provided risk-adjusted return of around 0.0664 and the value stock portfolio has provided a risk-adjusted return of around -0.0274.

Growth portfolios with a high-dividends to price ratio beat the market, returning 1.36 percent vs 1.12 percent for the Australian market portfolio. The return on the value stock portfolio, on the other hand, was 1.11 percent, which was lower than the growth stock portfolio and the market as a whole. When compared to value equities, a growth stock portfolio with a greater dividend to price ratio has a smaller standard deviation. The growth portfolio has delivered a positive risk-adjusted return of about 0.0529, according to the Sharpe Ratio. The Sharpe ratio of the portfolio comprising value stocks was roughly -0.0006, indicating that the portfolio underperformed the risk-free benchmark.

Boom and recession plays an important role in determining the performance of the value and growth stocks performance (Lev and Srivastava 2019). During boom economic cycle, the value stocks outperforms the growth stocks as growing confidence in the economy and consumer behaviour and easily availability of credit to the stocks that are classified as value stocks. In periods of recession, the growth stocks tends to outperform the value stocks as investors look to save their capital by investing in companies with proven track record of growth and stable operational environments (Greenwald et al 2020).

During the 1990s, the growth approach was the most popular investment strategy in the United States, although before to that, the value style of investing was the most popular. During the 1990s, when the notion of value investing was popular, investors were suspicious of the economy undergoing a fundamental transition (Asness et al 2015). Until the year 2000, when renowned value investing businesses and stock pickers believed value investing would no longer be the favored alternative for investing, the value investing method began to fade (Lauricella and Lynch 2019). However, the dot-com boom signaled the end of the growth approach, and value funds became popular in the following decade of 2000. The decade of 2010 saw the comeback of the growth strategy, and it is only recently that the value approach has begun to resurface. As majority of the data suggest that growth strategy has outperformed the value strategy mostly all the time in this decade, it was appropriate to conclude that value investing has been prevalent in the 2000 decade since then, value investing has lost its foundation and stock pickers struggle to choose outperforming stocks (John-Morgan and Vuuren 2021).

According to (ET 2022), the value investing around the world may broaden its reach and the value stocks may continue to outperform growth stocks and the market as whole. Hence, it is recommended for investors to follow the value investing approach in the month to come to extract value premium on the back of rising consumption in the economy (He, Xiang and Yin 2021).

References

Asness, C., Frazzini, A., Israel, R. and Moskowitz, T., 2015. Fact, fiction, and value investing. The Journal of Portfolio Management, 42(1), pp.34-52.

Calandro Jr, J., 2016. Value Investing General Principles. Available at SSRN 2575429.

Four reasons why the rally in value stocks may broaden in 2022 (2022). Available at: https://economictimes.indiatimes.com/markets/stocks/news/four-reasons-why-the-rally-in-value-stocks-may-broaden-in-2022/articleshow/88949936.cms?from=mdr (Accessed: 3 April 2022).

Greenwald, B.C., Kahn, J., Bellissimo, E., Cooper, M.A. and Santos, T., 2020. Value investing: from Graham to Buffett and beyond. John Wiley & Sons.

He, G., Xiang, S. and Yin, J., 2021, December. Corporate Value Investing Research in Covid-19-A Case of Starbucks. In 2021 3rd International Conference on Economic Management and Cultural Industry (ICEMCI 2021) (pp. 2790-2796). Atlantis Press.

John-Morgan, B. and van Vuuren, G., 2021. Spectral analysis and the death of value investing. Cogent Economics & Finance, 9(1).

Lauricella, T. and Lynch, K. (2019) Value Investing: A Deep Dive Into Performance, Morningstar, Inc.. Available at: https://www.morningstar.com/articles/950553/value-investing-a-deep-dive-into-performance (Accessed: 3 April 2022).

Lev, B. and Srivastava, A., 2019. Explaining the recent failure of value investing. NYU Stern School of Business.