Value versus growth investing – the great rotation and what’s next

Investors have long debated the merits of value investing versus growth investing. It’s an age-old argument spanning back to the dawn of investing itself. The debate has recently resurfaced with a vengeance as value has started to claw back years of lost ground.

But what‘s the difference between value and growth investing, and is one better than the other?

We think it makes sense to use different investment styles and strategies to build a portfolio. To start with, it’s worth considering what each style of investing aims to achieve.

This article isn't personal advice. If you're not sure if an investment is right for you, ask for financial advice. All investments and any income they produce can fall as well as rise in value, so you could get back less than you invest. Past performance is not a guide to the future.

What is value investing?

Value investors look for lowly-valued companies that have fallen on hard times and could hold potential for a recovery. They want to invest in companies they believe are ‘cheaper’. In other words, sitting at a lower share price than their true worth, but could bounce back or undergo a turnaround.

Sometimes a company’s assets or profit potential isn’t fully reflected in its share price. This could be for a number of reasons. It might be that it’s not hit its targets, perhaps there’s been a change of management, or maybe there’s just a gloomy investor outlook for its part of the market.

This can help create opportunities for investors. If this is the case, and the company undergoes a turnaround, the true value of the stock could be realised, which could mean a potential strong increase in the share price although nothing is guaranteed.

One of the difficulties with this approach, is differentiating between the companies with rebound potential and those that are cheap for good reason. Some could be 'value traps' – where companies are in terminal decline and the price will just fall further. It's important to try and avoid these.

What is growth investing?

Growth investors look for high-quality companies that have the potential to deliver above-average growth, as measured by metrics like earnings, revenues, or cash flows.

The belief is that a company that can grow its earnings rapidly could see its share price rise faster than the average.

These types of companies tend to be in growing industries that change quickly, like technology, and are often seen as some of the world’s most exciting businesses.

Investors expect these companies to innovate and develop the products or services they offer quickly, building a competitive advantage and dominant market position other companies will struggle to replicate.

To grow quickly, these companies typically reinvest their earnings or profits back into the business. They tend to do this instead of paying out dividends to investors so they can fuel the next stage of their growth.

Growth investors are normally more comfortable paying a higher price for high-quality businesses, compared to their more value-oriented peers. That said, there’s naturally a price at which even the fastest growing companies will be overvalued, and investors shouldn’t get caught up in chasing growth at any price.

Is there a best of both?

Warren Buffett, one of the most famous investors of all time, thinks both strategies are intrinsically linked. While he’s a value investor at heart, he believes assessing growth potential is a key part of valuing any investment.

There’s also an alternative investing strategy that blends some of the aspects of growth and value investing together. It’s a strategy known as GARP, or growth at a reasonable price, popularised by famed investor Peter Lynch.

This strategy, when used correctly, focuses on companies that can grow their earnings steadily, but can be bought at a lower price than the earnings potential suggests they should be.

The great style rotation and what’s next

The environment that’s suited growth stocks over the majority of the last 13 years changed in late 2020. This is commonly referred to as a change in market leadership or a style rotation.

Over this period, value has underperformed growth, marking the longest period of underperformance since World War II. This was amplified by the pandemic in 2020, during which value had its worst year in recorded history.

This was driven by a number of factors. Since the global financial crisis (GFC) in 2008, we’ve experienced low levels of inflation, and stubbornly mediocre economic growth. Central banks desperately tried to kick start growth again, cutting interest rates close to zero to stimulate economic activity. This lends a strong tailwind to growth investing and made it an uphill battle for value investors.

But nothing lasts for ever.

Growth’s outperformance of value, which was boosted by the pandemic-induced demand for online services, digital entertainment, and technology that enabled us to work from home, peaked in the latter part of 2020.

Pharmaceutical company Pfizer announced that it had successfully developed a vaccine for COVID-19 in November 2020 and this ultimately triggered the beginning of a comeback for value investing.

Since then, we’ve seen high inflation across many economies driven by supply chain disruption and spiralling energy prices, which have stemmed from Russia’s invasion of Ukraine.

In response to this, central banks have hiked rates to try and curb inflation. A rate rising backdrop is especially painful for growth stocks. As a result, the more traditional value sectors like basic resources, consumer staples and financials have performed better than other, more traditional growth sectors like technology, software and telecoms.

Many believe, at least for the first part of 2023, that inflation will remain stubbornly high, and central banks will continue hiking rates, albeit at a slower rate with recessionary clouds lingering. This backdrop is likely to continue to benefit value stocks.

However, if inflation and rates fall quickly, back to more normal levels, we could see the performance gap between growth and value stocks narrow.

Investment themes in 2023 – what to watch

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