Growth versus value investing is one of the major debates in the investment world. Growth stocks seem to have outperformed their value counterparts over the past few years. But the winning streak of growth investing took a hit this year with value stocks regaining lost glory.
It is currently speculated that value investing will likely continue its winning run in the upcoming years. Hence, adding potential stocks to one’s portfolio might prove to be an ideal option in the current scenario.
Value vs. Growth Investing: Long-Drawn Debate
Value investors seek to invest in stocks that are believed to be trading at a discounted value. Investors look for favorable value ratios including low price-to-earnings (P/E) and price-to-book value (P/B) ratios to identify potential value stocks. While a significant number of these stocks are also expected to come with solid dividend payments, these stocks are also expected to moderate growth prospects.
Meanwhile, growth investors generally invest in stocks that expected to have higher earnings and revenue growth compared with their industry peers. While these stocks rarely pay dividends, they also come with high P/E and P/B ratios. It has long been debated that growth stocks are poised to provide higher returns compared to value stocks. However, impressive performances of value stocks this year in addition to different studies have shown that this may not always be true.
How Value Stocks Perform in the Long Run?
Before going into a discussion about this year’s performance, let’s have a look at some studies that indicate that value stocks tend to outperform growth stocks in the long run. At first, we will have a look at the outcome of the study done by Eugene Fama and Ken French, two highly-respected scholars in the field of finance. They created a set of growth and value data dating back to 1928.
In this study, the two used book-to-market ratios (the ratio of book equity to market equity) to define growth and value. Their study showed that large value stocks and small value stocks have returned 11.9% and 14.9% per year, respectively, from 1928 to 2004. However, large growth and small growth stocks posted average yearly returns of respective 9.2% and 9.6% during the same period. It clearly shows that value stocks have outperformed their growth counterparts during the defined time frame. (Read More)
Another study by Bank of America/Merrill Lynch also established the fact. The study found that from 1926 through 2016, value stocks posted an average per year return of 17%, while growth stocks returned 12.6%. Moreover, chief investment strategist of America/Merrill Lynch said: “Value has outperformed Growth in roughly three out of every five years over this period.” Another interesting fact that came out from the study is that value stocks have outperformed growth during periods when the economy expanded.
Value Stocks Outperform Growth Stocks So Far in 2016
To compare the performance of value stocks with growth stocks so far in 2016, we have taken the help of the performance of iShares S&P 500 Value (IVE) and iShares S&P 500 Growth (IVW). IVE has returned 13.7% in the year-to-date frame, significantly higher than IVW’s gain of 4.1%. It is the first time since 2011 that IVE has outperformed IVW. While the value ETF has outperformed the growth fund during both halves of this year, IVE’s gain of 8.3% during the second half is much higher than the gain of 4.9% registered in the first.
Stronger performance of the U.S. economy during the second half compared to the first may be an important factor behind this. We have already seen in Bank of America/Merrill Lynch’s study that value stocks generally outpace growth ones during economic expansion. Recently released economic data including encouraging third quarter GDP growth, nine-year high consumer confidence, nine-year low unemployment rate and expanding manufacturing as well as services sectors also indicate that the U.S. economy is on track to post much better second half numbers.
5 Value Stocks to Buy
In this encouraging environment, one may consider investing in value stocks in order to prepare their portfolios for robust returns in 2017. In order to screen out potential value stocks, we have considered only those stocks that have a Zacks Rank #1 (Strong Buy) or #2 (Buy) and a value score of ‘A.’ Our research shows that stocks with a Style Score of ‘A’ or ‘B’ when combined with a Zacks Rank #1 or 2 offers the best upside potential. These stocks also have lower forward P/E and P/B ratios and favorable growth potential.
Mitsubishi Corp – ADR (MSBHY) operates as a general trading company worldwide. The company has a forward P/E ratio of 10.47, compared with the industry average of 18.27. It also has a P/B ratio of 0.83, lower than the industry average of 1.90. This Zacks Rank #1 stock has an expected earnings growth rate of more than 100% for the current year compared with the industry average of 7.1%.
Preferred Apartment Communities Inc (APTS) acquires and operates multifamily properties primarily in the U.S. The company has a forward P/E ratio of 10.49, compared with the industry average of 18.64. It also has a P/B ratio of 0.42, lower than the industry average of 1.72. This Zacks Rank #2 stock has an expected earnings growth rate of 12.1% for the current year compared with the industry average of 3.3%.
Cosan Ltd (USA) (CZZ ) is a leading global ethanol and sugar company in terms of production. The company has a forward P/E ratio of 10.29, compared to the industry average of 22.59. It also has a P/B ratio of 0.22, lower than the industry average of 1.48. This Zacks Rank #2 stock has an expected earnings growth rate of 37.7% for the current year.
Axis Capital Holdings Limited (AXS) is a Bermuda-based global provider of specialty lines insurance and treaty reinsurance. The company has a forward P/E ratio of 14.90, compared to the industry average of 17.56. It also has a P/B ratio of 1.04, lower than the industry average of 1.24. This Zacks Rank #2 stock has an expected earnings growth rate of 5.1% for the current year.
Great Plains Energy Incorporated (GXP) engages in the generation, transmission, distribution and sale of electricity. The company has a forward P/E ratio of 14.79, compared to the industry average of 17.43. It also has a P/B ratio of 1.46, lower than the industry average of 1.58. This Zacks Rank #2 stock has an expected earnings growth rate of 31.3% for the current year compared with the industry average of 3.4%.
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