Growth stock investing focuses on companies that are expected to grow at an above-average rate compared to the broader market, while value investing focuses on investing in underpriced companies whose share prices are trading below an estimate of the companies’ intrinsic value.
Over the past 100 years, value stock investing has trounced growth stock investing. However, over the shorter time period since the Global Financial Crisis in 2008, growth has outperformed and the valuation gap between growth stocks and value stocks reached extremes in 2020. At that time, we said the accelerating trend in favour of growth stocks was likely a sign that the outperformance was nearing an end, and value would begin to outperform.
The chart below, courtesy of AQR Capital Management, shows the disparity between value and growth stocks on a global basis going back to 1990. The valuation of the top 30% of stocks (the most expensive) and the bottom 30% (the cheapest) are compared with one another, and the gap between the two is compared to the historical average – the “Z-Score” – with a positive score reflecting a premium valuation for growth stocks.
The chart shows that the premium valuation afforded growth stocks globally peaked in the middle of 2020 and subsequently began to reverse.
However, following the recovery in more speculative stocks since June of this year, growth stocks have gained the upper hand again – with the valuation gap between growth and value stocks now back in the top 2% of all observations (98th percentile), and in line with the dotcom bubble, although still below the peak in 2021.
In other words, despite the strong resurgence in value stocks since 2020, the valuation gap between growth and value stocks is almost as wide as it has ever been – and value stocks likely have some way to go before valuations come back in line with historical norms. Said differently, the odds remain high that returns from value stocks over the next several years will be well in excess of those from growth stocks.
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