Growth & value investing: five things you should know

There has been a stark mismatch in returns from shares at opposite ends of the style spectrum so far this year. Technology stocks have come off the boil in dramatic fashion, just as energy producers and mining stocks have gotten into their stride.

These events have raised the possibility of more permanent “regime change” across stock markets.

But will this last and should investors alter their approach to buying shares and funds?

Growth and value stocks

Growth stocks are generally understood to be those that can grow their earnings faster than the market average independently of economic conditions, year in, year out.

Value stocks are essentially those that score well in terms of dividend yield or assets versus market value, a low “price to book” ratio (a financial ratio used to compare a company's current market price to its book value – the value of company’s assets). Credentials like these can indicate a company has been overlooked in the past or is just plain out of favour with investors today.

Growth stocks and jam tomorrow

If a company is growing its earnings consistently every year, its annual earnings in, say, ten years’ time stand to be immense compared with today. That means a very large part of the company’s total profits over the next ten years is going to be made in the latter stages of that period.

However, all those earnings a long way out are worth less to an investor in today’s money if inflation and interest rates are high in the meantime. Jam tomorrow doesn’t cut it quite so well.

Value investing as a long term strategy

Value investing has a reputation for delivering excellent returns over the very long term. However, that could be partly down to a lack of true technology innovators in the past. The long term returns from what we now term value stocks may simply be close to the long term average.

Or it could be down to dividends. Over the long term, dividends have accounted for a substantial proportion of total returns. It stands to reason that owning value stocks tends to accentuate the positive effects of earning then reinvesting dividends.

Growth stocks will rise again

Growth stocks will return to favour at some point, it’s just not likely to be until investors have a clearer understanding of just how far inflation and, by implication interest rates, will rise over the next few months and into 2023.

It’s inconceivable that technological change will become less important in the years that lie ahead. The electric vehicle revolution, the desire to automate, shortages of water, energy and decent housing around the globe, and strategies to tackle climate change all call for more technological innovation.

Maintaining a balance is rarely a bad idea

Owning a diversified portfolio of investments may lessen the risk of being invested in the wrong part of the market when an entirely different area is making headway.