Having a portfolio of growth-focused and value-focused stocks can help smooth your returns over the long haul, since the two styles take turns leading the market.Getty Images/iStockphoto
John Reese is CEO of Validea.com and Validea Capital, and portfolio manager for the National Bank Consensus funds. Globe Investor has a distribution agreement with Validea.ca, a premium Canadian stock screen service. Try it.
'You can't have your cake and eat it, too": For centuries, mothers have related this adage to inflexible children. Want to buy that toy you've been saving up for and still have plenty of money to spend at the arcade? Sorry, you'll have to choose. Want to sleep late but still get to the beach before it gets too crowded? Can't do both, kiddo.
As usual, of course, mom is right. But when it comes to investing's great "either/or" – that is, the growth or value debate – you can have your cake and eat it, too.
That's because the great growth versus value debate is, in fact, a false choice. For decades, investors have pitted one against the other: Either you are a growth investor and buy shares of fast-growing companies, which tend to offer flashy products and trade at a premium, or you are a value investor who buys shares of unloved firms whose shares are dirt cheap because they are in boring industries or are going through short-term trouble.
But confining yourself to either value stocks or growth stocks is only limiting your portfolio's potential. At certain times, you'll be able to find more attractive growth-type picks; at other times, the market will be offering more value-type plays.
Having a portfolio of growth-focused and value-focused stocks can also help smooth your returns over the long haul, since the two styles take turns leading the market. In fact, in the 1996 edition of his What Works on Wall Street, quantitative investing guru James O'Shaughnessy laid out his "Cornerstone Growth" and "Cornerstone Value" approaches, each of which, his testing showed, would have fared quite well over a four-decade period. But using both approaches, resulting in a portfolio of some value stocks and some growth stocks, would have produced even better risk-adjusted returns, he found.
But the fallacy of the growth-versus-value notion goes even deeper, I think. That's because implicit in the debate is the idea that any given stock is either a value stock or a growth stock, and that's just not true. Just as stocks can have both value and momentum qualities (something I discussed in my last column), so too can they have both growth and value characteristics. Consider what none other than Warren Buffett has had to say on the topic: "Market commentators and investment managers who glibly refer to 'growth' and 'value' styles as contrasting approaches to investment are displaying their ignorance, not their sophistication," he wrote in his 2000 letter to Berkshire Hathaway shareholders. "Growth is simply a component – usually a plus, sometimes a minus – in the value equation."
I recently came upon some great examples of how growth and value are not mutually exclusive using the O'Shaughnessy-based Guru Strategy investment models I run. One of these strategies is value-focused, while the other is growth-focused. The value model looks for large companies – annual sales should be at least 1.5 times the market average – with above-average cash flows and high dividend yields. The growth model looks for companies that have increased earnings per share in each year of the past half decade, and which have 12-month relative strengths above 70 (i.e., good momentum). The model also includes a value component, targeting stocks with price-to-sales (P/S) ratios below 1.5.
It's difficult to pass either of these models, but recently I found a duo of stocks that pass both of them. That's a rare occurrence, and a great example of how value and growth are not mutually exclusive, as some pundits would have you believe.
First off, there's AXA, a Paris-based financial company that's involved in life insurance, property and casualty insurance, asset management and banking. The firm has the size (market capitalization of $65-billion [U.S.], $133-billion in trailing 12-month sales), cash flow ($2.73 a share versus the market mean of $1.77) and dividend (4.1 per cent) needed to impress the O'Shaughnessy-based value model. It also has the consistent earnings growth, solid 12-month relative strength (77) and low P/S ratio (0.49) required to pass the growth model.
The second growth/value dynamo is also a foreign firm that trades on U.S. exchanges: German auto giant Daimler AG. Like AXA, Daimler is very large, with an $89-billion market cap and $154-billion in trailing 12-month sales. It also has a stellar $13.05 in cash flow per share and 3.4-per-cent dividend, allowing it to pass the O'Shaughnessy value model. Its steady earnings growth over the past five years, 72 relative strength and 0.58 P/S ratio, meanwhile, earn it high marks from the growth strategy.
Are Daimler and AXA value stocks? Growth stocks? In the end, what you label them doesn't matter. What does matter is that these stocks are strong across a variety of different metrics – some growth, some value and some that have to do with other factors, such as quality.
Stick with stocks like that and over the long run your portfolio should reap the benefits.