Growth vs. Value Stocks: What’s the Outlook Post Pandemic?

Apple (AAPL) and Microsoft (MSFT) both have market caps of more than $2 trillion. Why? In part because they’ve kept a steady eye on growth.

Meanwhile, Warren Buffett, considered by many to be the greatest investor of our time, has amassed a personal fortune of more than $100 billion through mid-2021. Why? Because he’s kept a steady eye on value.

If you’ve followed the stock market for a few years (or decades), you’ve probably observed a steady ebb and flow of value versus growth stocks. Like most aspects of the financial picture, that ebb and flow got upended last year by the pandemic, with growth getting a huge lift at first and value sagging. That was followed by growth stocks tailing off and value rising in early 2021 as vaccines helped send COVID-19 cases dramatically lower in the United States and the economy began to recover. 

What are growth and value stocks? They’re often considered important investing styles in equity. But at any given time, there can only be one leading performer. So, sometimes growth stocks outperform, and sometimes value stocks are the leaders. Until this year, growth had been winning the battle for a long, long time.

“Which style you might favor typically has a lot to do with your objectives, risk tolerance, and investment horizon,” said Viraj Desai, Senior Portfolio Manager, TD Ameritrade. “Although you shouldn’t change your overall investment plan without keeping those key parameters in mind, you also don’t want to stumble along blindly when fundamentals undergo a tectonic shift, as they did last year.”

A lightning strike like a pandemic can cause the growth-versus-value paradigm to change quickly. As an investor, it’s important to understand which category might be positioned for strength coming out of a crisis. You might consider some changes while keeping any moves within the context of your long-term goals.

There’s room for both value and growth in most investors’ diversified portfolios.

Value vs. Growth Stocks: What’s the Difference?

Let’s start with the basics. Growth is typically defined by metrics such as earnings per share (EPS) and sales per share (SPS). Typical characteristics of growth stocks include rising earnings and sales (“revenue”). High growth rates often drive higher “earnings multiples,” meaning investors show a willingness to pay more per unit of current earnings, with the expectation that growth should eventually “catch up,” so to speak.    

How do investors typically measure these so-called “multiples”? Here are two common ratios: 

• Price-to-earnings (P/E) ratio. Basically, this is a company’s stock price divided by EPS. It could be based on the past 12 months’ earnings per share (“trailing P/E”) or on the company’s projections (“forward P/E”).
• Price-to-book value (P/BV or P/B) ratio. This is the stock price divided by the stated value of its net assets (total assets minus intangible assets and liabilities).

If the growth rate is high, then investors might be willing to pay more for a company’s stock, and these ratios will be higher. So, in a sense, high P/E and P/B ratios define growth because no one can guarantee the actual future growth rate of earnings.

About a decade ago, the average P/B for value stocks was around 1 versus about 4 for growth stocks. Since then, we’ve seen P/B move higher for value and for growth.

Growth stocks tend to show up in fast-growing industries like technology, pharmaceuticals, and other modern industries. Think of the “FAANG” stocks: Facebook (FB), AAPL, Amazon (AMZN), Netflix (NFLX), and Google parent Alphabet (GOOGL). These are among the classic growth stocks of our day.

Conversely, value stocks typically have low P/E and P/B ratios and lower expected growth rates. Financial companies, automakers, and commodity producers are often priced at low valuations and thus get called value stocks.

If you’re looking at individual stocks, consider looking first at the industry. Is it associated with growth? Next, consider the P/E and P/B ratios. Here’s one common rule used by analysts: If the P/E is above 20, and/or the P/B is above 3.0, it’s probably a growth stock. 

Curious about the contents of a mutual fund or exchange-traded fund (ETF) in your portfolio? Fund analyses from companies like Morningstar often contain a “style box” (see figure 1) that lets you know if the fund favors value, growth, or a blend, as well as whether the fund is considered small, medium, or large. TD Ameritrade clients can view style boxes by logging in to their tdameritrade.com account and selecting the Research & Ideas tab > ETF or Mutual Funds > Profile. Clients can also use the TD Ameritrade screener tool to filter by growth or value funds, plus a whole host of other filters.

COVID-19 and the Growth/Value Equation

As bad as the pandemic has been, and as much as the economy has suffered, no crisis lasts forever. This appeared to give value a rebound versus growth as the world began to emerge from this unprecedented period. At the peak of COVID-19, the so-called “growth-value” spread hit levels last seen two decades ago during the dot-com boom (see figure 2). 

During the first phase of the pandemic in 2020, growth—already on a roll thanks to the success of huge information technology firms—gathered steam as the economy reeled from shutdowns and investors gravitated toward familiar names like AAPL, AMZN, and FB.

Meanwhile, value stocks in the Financials and Consumer Staples sectors lost ground as investors worried about the impact of the crisis on consumers.

“Growth likely benefited early in the pandemic because so many investors wanted large, familiar names that had weathered challenges like the 2008 recession and a 2015-16 ‘earnings recession,’ ” Desai said. “But you could argue the move reflected a scramble away from value as much as one toward growth.”

When the economy shut down the way it did in early 2020 with people stuck at home, consider which companies took the worst hit. Financials made the list because large and (especially) small banks make much of their money from loans to Main Street. That means small businesses and people who want to buy homes—both economic areas that suffered greatly due to shutdowns and resulting unemployment. 

Two other traditional value sectors that initially got hurt were Energy and Industrials. Crude fell to all-time lows in the early days, and it’s pretty easy to understand why. People all around the world stayed home, road and air traffic collapsed, and workplaces closed down. The world simply needed far less crude than producers were putting on the market. The Energy sector, whose fortunes are tied closely to crude, fell more than 30% in 2020.

Industrials—another value sector that tends to perform better in a recovering economy and poorly in a recession—also got clipped. Building projects slowed and so did demand for major home appliances as people lost their jobs in the first weeks of the pandemic. Overall, the Industrials sector lagged the performance of the S&P 500 Index (SPX) throughout 2020.

Inflation Fears, Lockdown Easing Gave Value Stocks New Life

Things changed quickly in late 2020 and early 2021 when vaccines were introduced and the pandemic started to lose its potency (at least in the United States). Hard-hit value stocks that had shown such extreme underperformance compared to growth stocks began to revert. Value has outperformed from the peaks of the COVID-19 lockdowns, driven by a reversion in energy prices, the reopening trade helping Industrials, and the prospects of rising rates and higher levels of economic and trading activity lifting Financials. 

“In addition, inflation scares surfacing by mid-2021 helped growth to underperform, given that future earnings command a lower premium in an inflationary environment,” Desai said. “That’s the same reason longer-duration fixed-income assets began underperforming, though they showed signs of bouncing back by June and July. Through mid-year 2021, value was helped along by the prospects of current earnings growth and the perception of possible lower impact on the sector from inflation.”

In fact, research and data firm MSCI (which tracks the performance of growth versus value over time) stated that for the year that ended May 31, 2021, world value stocks slightly outperformed world growth stocks over the previous 12 months. Value gained approximately 41% during that period versus 40% for growth. It was the first time value outperformed growth in any 12-month period since July 31, 2017. 

Growth Stocks Back in Driver’s Seat, but for How Long?

However, growth got back on track in June 2021 as the bond market rose again, sending yields down and possibly easing fear of inflationary pressure on growth stocks. The growth category outpaced value 39.7% to 37.9% for the 12 months that ended in June, according to MSCI.

That’s still relatively close, however, compared with growth’s surge in the early months of COVID-19. At the peak of the pandemic’s impact on the market in September 2020, a 12-month investment in growth stocks had increased 30.5% versus a 12-month return of -8.35% for value. That was a premium that far outweighed the previous 21st century peak for growth versus value recorded at the top of the dot-com market in 2000, according to MSCI data. If you’re wondering, value performance peaked versus growth in February 2001 after the dot-com bubble burst.

As you can probably see, the performance of these two categories depends a lot on macroeconomic factors. When you get into unprecedented eras like a dot-com bubble or a pandemic, that’s when you often see the most dramatic differences.

Growth, Value, and Zebra Stripes

So, how do you choose between growth and value? It’s a complicated picture, to say the least. Academic financial gurus Eugene Fama and Kenneth French famously declared value (in the form of low P/B ratios) to be one of the best factors for stock selection. But their subsequent research suggested that growth factors of profitability and reinvestment may be very similar in impact to value factors. It’s uncertain which matters more statistically.

In other words, when evaluating growth versus value, it’s tough to say if the zebra is white with black stripes or black with white stripes. 

Plus, times change. New technologies have the power to unseat the old order. Over the last several years, some growth stocks have enjoyed robust gains, even while some value shares languished. Then value found its legs again in 2021.

Still a Case for Value in 2021?

Those who said value got oversold in 2020 may feel vindicated now after its comeback in early 2021. By mid-2021, however, value was showing signs of dragging after a nice run. Is the value rally over?

“With the economy reopening over the last year, COVID-19 continues to affect value. A resurgence due to the “delta” variant could act as a drag on value, but value stocks tend to outperform in recoveries and could potentially still have legs,” Desai said. “One must not ignore the longer-term prospects of growth and some of the major innovations happening right now in growth stocks. Prudent investors will want to make sure they’re diversified across both.”

Also, keep in mind that individual companies can go through growth and value phases. Believe it or not, some of today’s steady dividend cash cows were once the upstart disruptors. Consider IBM (IBM), which has a dividend yield of more than 5%. In the 1960s, IBM was part of the “Nifty 50,” which also included stocks like General Electric (GE) and Johnson & Johnson (JNJ). Those companies were arguably the Apple and Tesla (TSLA) of their day. 

It gets back to those ebbs and flows of value and growth. Right now, it’s hard to remember because growth has dominated for so long, but after that peak in P/B for growth back in 2000, value outperformed growth for more than a decade. So, remember, things can change fast. Today’s TSLA can become tomorrow’s GE. Today’s high fliers can be tomorrow’s underachievers. 

Match Investments to Your Objectives

When it comes to choosing growth or value, it’s hard to say definitively which one is better. It may come down to your objectives:

• Are you looking for potential income? Many high-growth stocks, especially those involved in emerging technologies, don’t pay dividends. Some may not even have positive earnings but rather plow resources into continued growth. Well-established companies, many of which have a long history of dividends and dividend growth, may be priced for value.
• What’s your time horizon and risk tolerance? Shares of high-growth companies often experience higher volatility and may be more susceptible to short-term market dynamics. Having a longer investment horizon might help you weather any periodic downturns and give your investment time to realize potential growth.

Also, remember that investing doesn’t have to be an either-or, vanilla-or-chocolate, chunky-or-creamy, heads-or-tails decision. Choosing a mix of growth stocks and value stocks can help you build a diversified portfolio.

The risk of loss in trading stocks, can be substantial. Stock markets are volatile and can decline significantly in response to adverse issuer, political, regulatory, market, or economic developments.

Asset allocation and diversification do not eliminate the risk of experiencing investment losses.