Rotating From Growth to Value

Before we dive in to today’s topic, we must define some terms: What is a growth stock? What is a value stock?  And how do they differ?

A growth stock is a company whose earnings are expected to grow in a way that outpaces the market as a whole. Growth stocks typically plow their earnings straight back into company projects and, as such, seldom pay a dividend. Most tech stocks fit into this category.

People investing in growth stocks do not pay strict attention to such fundamentals as price-to-earnings ratios or even technical indicators, such as momentum and charts. Their focus is on finding companies that are constantly bringing new products into the market and spend most of their cash on research and development. Growth stocks are often thought to be less affected by fluctuations in the market as a whole.

A value stock, on the other hand, is one that is perceived to be trading at a lower price than its fundamentals would suggest. Value stock investors pay a lot of attention to classic Graham and Dodd fundamentals, such as a high dividend yield and low price-to-earnings ratios.

Value stock investors believe that the market isn’t always efficient and that they can find stocks that the stock market has undervalued. Growth stocks are more sensitive to the economy as a whole and tend to outperform when the economy recovers from a downturn, as has been the case so far.

It appears that we are seeing the beginnings of a rotation from growth to value as the recovery from the Great Recession gathers steam. This is combined with heightened risk aversion from investors with the stock market at such lofty levels.

A strengthening economy boosts value stock’s earnings so investors don’t have to chase growth stocks, such as the dotcoms. We are also seeing an increased search for yield; and stocks with good dividend yields are attracting more investor attention. In addition, the perception that the Fed’s tapering off of bond purchases will increase the cost of money is making it more risky for investors to speculate on growth stocks.

The market tends to act in a cyclical fashion regarding growth versus value, and we seem to be in the early stages of one cycle ending and a new cycle beginning.