Why Value Stocks Win in the End

 | Apr 04, 2014 | 1:00 PM EDT  | Comments
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Stock quotes in this article:

amzn

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csco

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nflx

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msft

After a month of outperforming "growth" stocks, some noise is being made that value stocks are set to "outperform" growth stocks. In March, large-cap value stock, measured by the Russell 1000 Value Index, is up 3.3% year to date while the Russell 1000 Growth Index is up 1.6%, respectively. In the second half of 2013, mutual fund inflows into value-oriented funds surpassed other fund inflows.  

Yet this idea of value stocks now being a better investment than growth stocks is misleading. Categorizing equities in this fashion is inaccurate. Indeed, I will agree so called value stocks -- companies with low price-to-earnings ratios -- are a better investment opportunity than so called growth stocks. But aren't they always? They are if you put aside trying to differentiate between the two.  

After all what makes an equity possess future value to the investor is most often growth. A value-seeking investor is after growth, he or she just doesn't want to pay up for it. If you can conceptualize that viewpoint -- value and growth are two sides of the same coin -- you will have reason to appreciate value, not just now but in general.  

What is leading to the preference of value-deeming securities today? It's precisely the growth aspect. Since 2008, the U.S. economy continues to improve. An overall improving economy suggests that business in general will experience improving financial operations. General overall demand for goods and services begins to pick up suggesting that even the biggest and most boring businesses will see sales growth. The result is that more investors migrate towards the lower valued equities in anticipation of that future growth.

 A simplistic way to view this thinking is this: in today's record high market is my capital better off buying Amazon (AMZN) at 80x forward earnings or Cisco (CSCO) at 11x forward earnings. If Amazon profits grow by 30% and Cisco's by 8%, which equity is likely to outperform? Put another way if the expectation is that Amazon will grow profits by 30% and Cisco by 8%, which is likely to do better if those rates come in below consensus?

It's not that value stocks are outperforming growth stocks. Value stocks are now being perceived as the better growth opportunity at the given price. Microsoft (MSFT), with its billions of free cash flow each quarter represents a better bet on growth than Netflix (NFLX). Prices are the ultimate source of information in the market.

A couple of years ago, I recall numerous value investors who were shorting Netflix when shares were trading north of $200. After Netflix shares fell through $100, many of those same investors went long Netflix -- at the lower price. The price being paid for future growth was a tremendous value.

 Don't let two separate definitions of growth and value send you in opposite directions. Both growth and value are components of finding quality investment ideas.

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