Personal Wealth Management / Expert Commentary

Fisher Investments Reviews How To Evaluate Growth vs Value Stocks

Fisher Investments’ founder, Executive Chairman and Co-Chief Investment Officer, Ken Fisher, discusses the differences between growth and value stocks and highlights how they each perform in varying economic environments. Ken explains how value stocks—priced at lower valuations—tend to be more heavily affected by the economic cycle and more reliant upon debt financing. Conversely, growth stocks trade at premium valuations and are generally less reliant on debt financing—enabling them to grow throughout the economic cycle. Looking forward, Ken believes a steepening yield curve could spur lending growth, which may be a tailwind to value stocks as 2024 progresses.

Transcript

Ken Fisher:

So whether value stocks will do better than growth stocks or vice versa is always a topic people debate. And that's been particularly true the last few years, and this year, 2024. It's also a topic that in my mind is often just fundamentally misinterpreted by most people.

First, an awful lot of investors just have inherent perma-biases on growth versus value one way or the other. The value people tend to believe in the notion of getting something cheap that isn't as bad as people think it is, and then it'll get bid up when people later realize that it's not that bad.

And the people that are biased in favor of growth tend to believe that growing sales and earnings build up pressure under a stock to go up as the sales and earnings rise relative to what the prior price was. There's some truth to both those arguments.

Or you could say that differently, you know in a somewhat sarcastic vein for both, as the value people are looking at picking up cigar butts off the street and seeing if they can get a few puffs. And the growth people are, you know, looking at paying a fancy price and hoping there's a greater fool to buy it away from them later, higher. And there's a grain of truth to both of those too.

The fact is, value stocks are inherently one selling at lower valuations, as the name implies, and are inherently more tied, linked to the growth of the economy and the industrial cycle, GDP cycle. Growth companies are inherently ones that can grow through the cycle, and neither of those things tell you anything about what happens to the stock price.

The fact of the value companies, or they end up being more like most Industrials, most Consumer Staples, an awful lot of consumer durables, Utilities, Real Estate, Energy in particular, most Material stocks. Growth stocks tend to be in the category of some luxury goods, which is subset of consumer durables, and an awful lot of Tech.

The fact is, another correct way to see this is that the growth companies, as companies, can grow when the economy's not because they're doing something new, different and better that people want somehow, some way.

And the value companies are doing more traditional things that are fundamental to the economy. But therefore rising sales and earnings dependent on the economy rising and selling, or having some new thing that reduces their cost of production or something. So they gain share relative to their competitors, but they're still usually seen as value companies.

The thing that tends to drive the stocks is the trade off between the financing of the two sources, contrary to what most people think. And it is true that most people think that rising interest rates hurts growth stocks. They don't. If that had been the case, growth stocks would have done worse than value stocks the last few years— you follow that—and they didn't. They did better.

When you have rising interest rates and you have a fear of an economy tightening. Remembering that the value side's pretty dependent on the growth of the economy. The value stocks get hurt because value companies are inherently dependent on debt financing to pay for whatever growth they can generate. They're dependent on primarily bank financing, but also other debt financing.

The growth companies are seen as higher quality, futuristic, and they have all kinds of financing opportunities. When the banks start lending less aggressively growth stocks typically do well because the value stocks are getting starved. Think of it like the big pigs and the little piggies at the pig trough.

The growth companies and the bigger companies are the ones that have the borrowing advantage. Big, strong balance sheets seen as high quality, futuristic and the littlest, lower quality more highly leveraged— which is the value side—is tending to be seen as the little piggies and the big piggies push the little piggies out of the way, out of the trough, away from the lending that the little piggies need to be able to grow and finance their growth.

When it goes the other way, and central banks cut short-term interest rates relative to long term rates, banks get more eager to lend, typically, because they take in deposits at the short term and make long-term loans. And as they get more eager to loan, that's like the trough that the piggies go to just got expanded. So now there's more slop in it. So now there's more room for the little piggies. And the value stocks do better.

The time for value stocks to do particularly well in the time period ahead is when the banks start lending more aggressively again, as central banks start cutting short-term interest rates relative to long rates and steepening the so-called yield curve, the spread between long rates and short rates. That has always been a prime tell on when growth tends to take over, when value tends to take over.

I think this year, as the year goes on, we'll start to see more of that. And what I've said so far as I've been speaking in April is that you can see that in the Energy part of the value world, Energy stocks, not so much in the rest of the value universe, but it is broadening out. And I expect that to continue like a toggle switch, not an on off light switch as 2024 progresses into 2025.

Thank you for listening to me. I hope this was educational for you and useful.

Voice of Ken Fisher:

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