Growth Stocks vs. Value Stocks: Who Wins In Today’s Market?
In the current market environment growth stocks may outperform value stocks. While value stocks tend to generate more free cash flow and pay higher dividends than growth stocks, some growth stocks have lower PEG Ratios (price earnings to growth rate) than their value counterparts. Over time, growth stocks can provide more capital appreciation than value stocks. And in today’s market, the appeal of growth stocks vs. value stocks is increasing.
The current low interest rate environment has led to the increased appeal of value stocks, and accordingly high valuations. Investors like the high dividend yields that value stocks provide, which in many cases is higher than the yields offered by 10 year US government bonds. As the 10-year treasury yield is currently below 2%, value stocks still command a premium. This may change when the Federal Reserve eventually raises rates; it may happen this year or next, but at some point rates will rise, and the appeal of value stocks may erode as a result.
Another factor that may work against value stocks is the strengthening US dollar. Many value stocks get a large portion of their revenues from overseas, and the current rising US dollar is reducing those revenues. Value stocks do not have much growth to begin with, so the rising US dollar reduces a large percentage of their growth. Growth stocks, on the other hand, have higher growth rates than value stocks; hence the negative impact on revenues in percentage terms is more muted.
Some growth stocks trade at similar valuations to value stocks in the same industry, despite the fact that the growth stocks have much higher earnings growth. For example, let’s take a look at Microsoft versus Google; Microsoft trades at 15.14 times estimated 2016 earnings, and has an estimated 5-year growth rate of 7.34%. On the other hand, Google trades at 16 .68 times estimated 2016 earnings, and has an estimated 15.68% five year growth rate. Google trades at a slightly higher valuation (16.68) than Microsoft (15.14), but Google’s estimated growth rate of 15.68% is more than twice as much as Microsoft’s 7.34%.
Another example can be seen in the beverage industry with Coca Cola and Starbucks. Coca Cola trades at 19.49 times estimated 2016 earnings, and has a 4.87% estimated 5-year growth rate. Starbucks, on the other hand, trades at 26.14 times 2016 earnings, and has an 18.48% estimated five year growth rate. Although Starbucks trades at a 30% higher multiple (26.14) than Coca Cola (19.49), its growth rate of 18.48% is almost 4 times higher than Coke’s 4.87% growth rate.
One caveat to keep in mind is that both growth stocks and value stocks can decline simultaneously in a market correction. As investors experienced in 2008, systemic market declines offer few places to hide. But if the market continues its bull run that began in 2009, growth stocks may offer better returns than their value counterparts.
Ideal Asset Management LLC is long shares of GOOGL for its clients
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