Growth stocks have significantly outperformed value stocks over the past several years. After all, growth stocks trade based on their anticipated growth and there was no reason to expect a slowdown since cheap money was being injected into the financial system by central banks. These dynamics, though, are changing, and the bull market has started to slow down. As such, growth stock earnings multiples could begin to decline as growth expectations are tempered by the current economy.
Below, ETF Database takes a look at why value stocks may be poised for a recovery amid the global economic slowdown as well as some value ETFs for investors to consider.
Growth vs. Value in a Bull Market
Value stocks have lagged the market since the Great Recession ended in 2009. Between March of 2009 and 2016, the iShares Russell 2000 Value Index ETF (IWN ) underperformed the iShares Russell 2000 Index ETF (IWM ) by over 25%. The added impact of compounding returns over this period of time translates to significant opportunity costs for investors who favored value stocks over growth stocks.
The S&P 500’s price-earnings multiple expanded 36.2% from 16.3x in 2011 to 22.2x in 2016 as growth expectations soared, according to Multpl.com. This means that a growth stock earning $1 per share in 2011 and trading at $16.30 may have jumped to $44.40 by 2016 if its earnings increased to $2 per share by that time. These dynamics explain why growth stocks tend to outperform value stocks during bull market cycles.
By comparison, a value stock would have only increased to around $32.60 if its P/E ratio never moved any higher than 16.3x over the same time frame. In addition, the P/E multiple would fall even further as investors sell these companies to invest in higher-growth alternatives. This may create a bigger discount from the stock’s “intrinsic value,” but without a catalyst to realize that value, many of these stocks simply languish during bull markets.
Sentiment Is Shifting to Value
The global economic slowdown in late 2015 and early 2016 may be shifting sentiment from growth towards value. According to the International Monetary Fund (IMF), growth in advanced economies is projected to rise just 0.2% to 2.1% in 2016 and hold steady in 2017. Growth in China is expected to slow to 6.3% in 2016 and 6% in 2017, which will weigh on emerging markets and aggregate global growth rates.
The global economic slowdown means that investors are expecting to see slower growth rates, and price-earnings multiples could contract. For the same hypothetical stock mentioned above that’s earning $2 per share, the stock price would fall from $44.40 to $34 per share if P/E multiples fall to 17×. Worse, the stock could see its price plummet even further if it earns less than $2 per share due to slower end markets for its products and services.
By comparison, value stocks may offer somewhat of a safe haven. They are already priced with lower P/E ratios, which means that valuations aren’t likely to fall as much. As such, the stock price should be more resilient. In addition, many value stocks trade close to their book value, which establishes a “price floor” of sorts. A stock that falls below book value could become a takeover target given that a buyer could, in theory, simply liquidate the assets and make a profit.
Investing in Value ETFs
Investors interested in limiting their downside by investing in value stocks can choose to identify individual equities using a variety of different techniques. The most popular value investing method was created by Warren Buffett’s mentor Benjamin Graham in the book “The Intelligent Investor.” Other popular value investing methods include Joel Greenblatt’s strategies for investing in special situations discussed in “You Can Be a Stock Market Genius.”
Those looking for a diversified portfolio of value stocks without having to do all of the research may want to check out exchange-traded funds (ETFs) focused on the space. ETF Database provides a comprehensive list of these ETFs in its Value ETFs List.
The most popular value investing ETFs on the list include:
When choosing between these ETFs, investors should carefully consider the criteria these funds use to determine “value” investments as well as the expense ratios that they charge.
The Bottom Line
Growth stocks have outperformed value stocks throughout much of the past decade amid the long bull market in equities. With the global economy now slowing down, value stocks could come back into vogue and give growth stocks a run for their money. Investors interested in taking advantage of this potential transition may want to check out value ETFs such as IWD, VTV, and IVE as an easy way to build exposure to value stocks into their portfolios.
