US value stocks such as oil, materials and financials are currently rising faster in terms of Ebitda and EPS than growth shares, according to recent research from Bloomberg, despite the growth investment style having enjoyed a 10-year bull run (see Chart 1).
Plurimi managing director Patrick Armstrong says of the results: “Earnings and Ebitda are the conventional metrics by which companies measure growth, meaning one would expect these companies to beat value here. As such these results are surprising.”
The chart below shows how far growth returns have beaten those of value since 2008. Since half the global market’s growth stocks come from the US it makes sense to look at this region when comparing these investment styles.
Chart 1: Russell 1000 Growth index vs Russell 1000 Value index (2008-18)
However, the chart below demonstrates that despite the increasing disparity between performance of value and growth, the Ebitda of the Russell 1000 Value Index is up 16% since the end of 2016, while the Ebitda of the Russell 1000 Growth Index increased by just 9% over the same period.
Chart 2: Russel Group 1000 Growth vs Russel Group 1000 Value: Ebitda
Source: Bloomberg
Similarly, chart 3 shows that growth in the EPS of the value index outperformed that of growth by 26% versus 22% since end of December 2016.
Chart 3: Russel Group 1000 Growth vs Russel Group 1000 Value: EPS
Source: Bloomberg
Surprise turnaround
Armstrong says: “These results might surprise investors. The whole point of value and growth is that growth stocks are expensive and generally grow faster, and the whole point of value stocks is that they are cheap but lag in growth. These figures show the opposite of this.”
He explains there are several reasons for this performance: “Value-style oil and material companies have seen price increases during this time; there has been a tailwind in terms of revenue growth from a low base; many of these companies have had lower earnings growth in the past so are playing catch up; and finally it may be that some growth companies like Netflix are growing on some measures but aren’t producing any earnings yet.”
Armstrong adds: “In my view, if we don’t go into a recession, value stocks are very well positioned to outperform. but that there has been so much crowding into growth seems to indicate that the market anticipates a downturn.”
Value rebound question
However, research manager at FE Charles Younes was not surprised by the figures. “Given the good global environment I am not surprised that cyclical, value companies such as financials and oil and mining have improved their earnings. Especially given the cut to corporate tax in the US.”
He was also less sure than Armstrong that value would rebound. “Although regulation of tech companies and quantitative tapering might benefit this style, I think we need stronger global growth than we are currently seeing. In addition, value only delivers over a short period of time – it rebounded in the second half of 2016 but soon gave way to growth.”
Growth seen ending
BMO investment manager Paul Green is more allied to Armstrong in his belief that we are nearing the end of growth bull run.
He says: “Growth companies are long-duration assets like government and investment-grade bonds. They benefit when rates and inflation are low or falling, just as discount rates used to value growth stocks are priced off bond yields and a risk premium.
“If we enter a period of higher yields, and therefore higher discount rates, it is reasonable to assume that growth stocks will look less attractive to investors.
Rising yield impact
“On the other hand, value stocks, which are short-duration assets tend to perform better in a rising yield environment, regardless of whether it is real growth or inflation that is pushing growth higher.
“In addition, accelerating growth has come at the same time as heightened geopolitical concerns. So although earnings have been increasing for value companies, investors have by and large stuck to the perceived safe haven of predictable growth with low earnings volatility. This has made growth stocks more expensive and value stocks cheaper.”
As such Green feels that many growth companies are overvalued: “At some point investors are going to focus on the price being paid for the growth they are getting from a company.
“We have been in a somewhat strange environment since the advent of quantitative easing (QE) where bond yields have been anchored at record low levels. It is only recently that central banks have moved from QE to quantitative tapering (QT) and although the implications of this are unknown, it is fair to say that the environment we have been in for the past ten years with record low volatility is unlikely to be repeated as this process is reversed.”
