When charting the outperformance of growth stocks vs. value stocks, it is tempting for a portfolio manager to try and call the unwinding of that trade to truly make a name for themselves. However, that is a daunting venture and one that could force you to say goodbye to your career as well. To time the turning point of this trade is extremely hard. Every time the market gets a bit of an unwind, it tends to get excited asd ask, "is this it?"
Growth stocks are those that grow significantly above the average growth rate of the market. These names, which offer strong earnings growth, also tend not to pay dividends.
Value stocks are traditionally defined as those that are extremely undervalued based on fundamental metrics vs. the market, so they present an opportunity if one believes in mean reversion.
The technology sector is full of growth stocks while the energy, financials, industrials groups tend to consist of value stocks, in today's environment.
How much an investor is willing to pay for growth now is debatable, as we are now in the "growth at any price" model.
Some of the largest stocks on the Nasdaq, or "Nascrack" as it's being called in some circles, are trading at P/Es of 100x plus. Even Amazon (AMZN) has a P/E ratio of around 144x. Anyone looking to buy here using traditional metrics such as P/E or EV/EBITDA would be dumbfounded. But then when you look at earnings per share growth rate, operating margins, amount of cash generated in the business and the growth, you see it in a different light.
If you brush off your old CFA books, intrinsic value is defined as the expected dividend per share divided by the difference of cost of capital less the growth rate of that stock. Applying pure algebra, as the risk-free rate moves closer to 0, and the growth goes up and up, the intrinsic value can go up toward infinity. Of course, that doesn't mean stocks can keep going up forever. But this is an exercise to understand the momentum behind these stocks and why their value is trending higher.
We all know the Fed is not going to raise rates any time soon, in fact it is looking for ways to pump more money into the system and keep rates closer to 0 for a very long time. Who I am to argue with mathematics?
The biggest debate I have with pure value investors is around the rate-of-change argument. If you look at energy companies, for example, run your numbers, and spit out all the metrics, including dividend yield and cash flow per share and EV/EBITDA, they are all screaming buys. But they have been screaming buys for the past five years!
If you bought these stocks back when Brent oil prices were trading above $80/bbl., your fund would likely be severely underperforming, not to mention the angry investors throwing tantrums at their dwindling returns.
An old adage from Wall Street rings true, "cheap can always get cheaper." For a sector like energy, the best metric to use is to time the commodity cycle itself, the price of oil and its direction. As simple as it sounds, if the price of oil is flat to lower, there is essentially no earnings growth for the large-cap majors and E&P stocks, unless of course they find new oil and growth, but that is more the riskier geological plays.
Even with upward trending oil prices, they tend to capture just half of that margin upside due to higher costs and just being too big to move the needle effectively. On the way down, their earnings fall as they have a high fixed-cost base. This explains the perennial decline in these names, despite the value proposition.
There are select companies in energy space that can grow earnings and margins even in a flat oil price environment. That is pure growth. They are few and far between, but in these cases the value proposition makes sense.
Other than short bursts of squeezes, oil prices have been capped for years given the abundance of OPEC and U.S. shale supply. Taking it off the market simply delays the problem of it firing back when prices rise. That does not resemble a "tight" market. An opportunistic one, yes.
One thing to keep in mind is that when the entire world is positioned one way, growth over value, there can be times when we see periods of massive liquidity unwinds due to exogenous factors, or simply just profit-taking. One cannot forgive people locking in 50%+ gains in a matter of few months! The important point to distinguish is whether this is a short term unwind, or the start of a structural trend.
Just like a mathematical problem, work each side of the equation, which will help you justify whether there is a case to be made for earnings to grow for either growth or value and then reach a conclusion. Where else can one find such growth?
