The enduring benefits of value stocks in a growth-focused market

Numerous studies have shown that value stocks tend to outperform growth stocks over extended periods, particularly during periods of market downturns or economic uncertainty.

US stocks recorded their biggest weekly gains in three months recently as investors championed signs that major central banks remain on track to cut interest rates, together with the AI buzz creating legitimate optimism for sustainable growth and earnings.

But in the midst of a market environment fuelled by optimism surrounding growth stocks and the promise of AI-driven innovation, it’s crucial for investors to recognise the enduring importance of value stocks.

In fact, in this scenario of soaring market buoyancy, maintaining a diversified portfolio that includes value stocks will provide investors with stability, resilience, and the potential for long-term growth.

Value stocks, in essence, are shares of companies that are trading at a lower price relative to their fundamental value. These companies are often characterised by solid financial metrics, stable earnings, and attractive dividend yields. 

Unlike growth stocks, which typically trade at high valuations based on future earnings potential, value stocks are too-often overlooked by the market and may be undervalued relative to their intrinsic worth.

One of the primary reasons why investors should not dismiss value stocks is their potential for capital appreciation.

While growth stocks may capture headlines with their rapid price appreciation, value stocks have historically demonstrated the ability to deliver strong returns over the long term. 

Indeed, numerous studies have shown that value stocks tend to outperform growth stocks over extended periods, particularly during periods of market downturns or economic uncertainty. One prominent study often cited in the discussion of value versus growth investing is the research conducted by Eugene Fama and Kenneth French. Their paper, ‘The Cross-Section of Expected Stock Returns’ (1992), is frequently referenced in discussions about the outperformance of value stocks.

Furthermore, value stocks offer investors a margin of safety. As these companies are trading at a discount to their intrinsic value, there is often limited downside risk. 

Even if the broader market experiences volatility or downturns, value stocks can often hold up better due to their attractive valuations and solid fundamentals.

Another compelling aspect of value stocks is their dividend-paying potential. Many value stocks are established companies with a history of distributing dividends to shareholders. These dividends not only provide investors with a steady stream of income, but also offer a cushion during periods of market turbulence.

In addition, value investing is a disciplined and time-tested approach to investing. By focusing on companies with solid fundamentals, sound management and attractive valuations, investors can avoid the pitfalls of market speculation and short-term trends.

Instead, they can build a portfolio of quality companies trading at discounted prices, positioning themselves for long-term success.

Historical context

The debate between value stocks and growth stocks has indeed been ongoing for decades, reflecting differing investment philosophies and strategies.

Historically, both value and growth investing styles have had periods of success and underperformance, influenced by various economic and market conditions.

In the Post-Depression era, Benjamin Graham’s value investing principles gained prominence following the Great Depression, as investors sought undervalued stocks with strong fundamentals.

During the bear market of the early 1970s, value stocks outperformed growth stocks, as investors favoured defensive, dividend-paying companies in a period of economic uncertainty.

Then, following the burst of the dot-com bubble in the early 2000s, value stocks, particularly in sectors like utilities and consumer staples, outperformed growth stocks, which had become overvalued during the tech boom.

In terms of growth stocks, coming out of the 2008 financial crisis, growth stocks, especially in sectors like tech and healthcare, experienced significant gains. Investors favoured companies with robust earnings growth potential, driving up valuations for high-flying growth stocks.

Growth companies examples

Amazon has revolutionised e-commerce, cloud computing (Amazon Web Services), and digital streaming (Amazon Prime Video). It has achieved remarkable revenue growth, expanding its market dominance across various sectors.

But despite its success, Amazon faces scrutiny over antitrust concerns due to its market power. Additionally, maintaining high growth rates becomes increasingly challenging as the company matures and faces competition in its core businesses.

Similarly, Tesla has disrupted the automotive industry with its electric vehicles (EVs) and advancements in autonomous driving technology. It’s achieved significant market share in the EV market and demonstrated impressive revenue growth.

However, Tesla faces issues related to production scalability, supply chain constraints, and regulatory hurdles. Plus, its valuation remains a subject of debate, with sceptics questioning its ability to justify lofty market expectations.

Value companies examples

AT&T is a telecommunications conglomerate with diversified operations in wireless services, media, and entertainment. It boasts a stable dividend yield and generates consistent cash flows from its core businesses.

But the company is tackling challenges in its traditional telecom business, including competitive pressures and regulatory scrutiny. Its acquisition of Time Warner (now WarnerMedia) has also resulted in a significant debt burden, raising concerns among investors.

Elsewhere, Johnson & Johnson is a diversified healthcare company with a strong portfolio of pharmaceuticals, medical devices, and consumer healthcare products. It has a track record of innovation and resilience, with a history of dividend payments and steady growth.

Yet the firm faces legal and regulatory challenges, including lawsuits related to its talcum powder and opioid products. Additionally, generic competition and pricing pressures in the pharmaceutical industry pose challenges to its growth prospects.

As history teaches us, ultimately, successful investing requires a balanced approach that incorporates elements of both value and growth investing, tailored to individual risk tolerance, investment objectives, and time horizon.

While the recent rally in US stocks has been dominated by growth stocks and the very real excitement surrounding AI-driven innovation, to which they should have exposure, it’s essential for investors not to overlook the perennial value of value stocks.

Nigel Green, deVere CEO and founder