Value and Growth Stocks Are Both Off to the Races

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Thirteen months ago, I predicted that value stocks would race ahead of growth stocks.

As a refresher, growth stocks are shares of companies that grow their earnings at fast rates. Value stocks, on the other hand, are priced below their peers in spite of the sound fundamentals they offer.

With growth stocks having outperformed for the better part of a decade, I believed that we were already well past the point for the cycle to turn back to value.

My call for value stocks was based on two observations…

  1. Valuations on growth stocks had gotten extremely stretched
  2. Valuations on value stocks had become very attractive.

Through the start of summer, my call on value was looking pretty smart.

Value Raced Out to a Big Lead

As you can see above, at one point, the iShares Russell 1000 Value ETF (NYSE: IWD) was up more than 33%. The iShares Russell 1000 Growth ETF (NYSE: IWF) was up only 18%.

But then value stocks fell behind again as summer set in.

June 2021 was one of the worst months ever for the performance of value stocks relative to that of growth stocks.

In June alone, the iShares Russell 1000 Value ETF trailed the iShares Russell 1000 Growth ETF by an astounding 7.4%.

That was only one of 17 times in 42 years (504 months) that value has trailed growth by more than 5% in a month.

Then value trailed growth again in July and August, as shown in the chart below.

Growth Comes Roaring Back

All of the initial lead that value stocks had over growth since I made my call for value last September is now gone.

The two indexes are in a dead heat – and a dead sprint.

Both Value and Growth Have Had a Great 13 Months

The silver lining is that both value and growth are up more than 30% in just over a year. Everyone wins!

I’m Pounding the Table for Value Again

While 13 months have passed, my thesis on and preference for value stocks remains unchanged.

Today, value stocks still look attractively priced, while growth stocks look expensive and risky.

First, let me quantify what I mean when I say “expensive.”

The market capitalization for the index of stocks that are trading at more than 10 times revenue has now reached historic proportions.

At $13.9 trillion, the market cap of stocks trading at 10 times revenue isn’t just more than what it was at the peak of the technology stock bubble in 1999 – it is twice as much!

Total Market Cap of Stocks with Price-to-Sales Greater than 10x

What you need to know is that history has not been kind to publicly traded stocks that trade at more than 10 times revenue.

Over the past 32 years, these stocks have generated an average annualized return of negative 0.3% versus an average annualized return of 11% for the overall market.

That is terrible underperformance.

Meanwhile, you can find value stocks today that offer earnings yields in the low to mid teens.

If you can build a diversified portfolio of stocks trading at those prices, you will set yourself up for solid future performance.

The earnings yields offered by value stocks are far superior to those of growth stocks, the overall market and bonds of all kinds.

Cheap Stocks Currently Have Superior Earnings Yields

I recently wrote about the attractive earnings yields that can be found in overlooked commodity producers today.

I’ve also repeatedly pointed to homebuilders offering a similar opportunity.

Over the past 42 years, the iShares Russell 1000 Value ETF has outperformed the iShares Russell 1000 Growth ETF 51% of the time.

Unsurprisingly, after a full decade of growth stocks outperforming value stocks, growth stocks have gotten dangerously expensive while value stocks are cheap.

Overwhelmingly, data favors value stocks today – and it is time for the cyclical pendulum to swing back to value for a while.

Keep this in mind as you make plays in the year ahead.

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