Growth or Value in a Crisis?

Conventional wisdom suggests that value investing (buying companies at prices lower than their intrinsic value with a view to realise that value in the future) outperforms growth investing (buying companies looking to grow their revenue and market share, and therefore grow their overall value). That is, it had been conventional wisdom up until recently.

Conventional wisdom suggests that value investing (buying companies at prices lower than their intrinsic value with a view to realise that value in the future) outperforms growth investing (buying companies looking to grow their revenue and market share, and therefore grow their overall value). That is, it had been conventional wisdom up until recently.

Based on the MSCI World Growth and Value indices (USD), growth investing has outperformed value over the last 13 years, with growth up +90% on a relative basis since the end of 2007. This rotation of fortunes has sparked an ongoing dialogue regarding the merits of these investing styles in a modern context. But how has the Coronavirus pandemic affected the growth vs value story?

2020 has witnessed levels of market volatility not seen since the global financial crisis in 2008 and, on average, equity markets fell -21.8% in Q1. During the first three months of 2020 the growth index fell -15.4%, whilst its value-focused opposite fell -27.5%. Clearly, investing for growth has been the winner, despite a reputation for carrying more risk. The April rebound told the same story, with growth up +12.7% vs value at +8.6%

If we dig a little deeper, the underlying sector returns are a mixed bag. As you may expect, more defensive sectors such as Utilities, Health Care and Consumer Staples fared well, relatively speaking. This is no surprise. These sectors provide services that remain in high demand during a downturn.

More cyclical sectors, such as Financials, Real Estate and Materials fell much further. When global growth slows property markets contract, banks’ profitability stalls and manufacturing diminishes. The Energy sector also fell -45%, due largely to a collapse in the oil price.

What has been interesting to note is how defensive some of the more growth-oriented sectors have been. Higher valuations suggest that in periods of market stress, lofty growth stock prices fall further. Despite this, the likes of Communication Services and Information Tech have held up well. Technology has provided stellar performance for investors, returning +87.8% over five years to the end of March 2020 and falling only -13.0% over Q1.

It is true, valuations on tech stocks are some of the highest around. At the beginning of the year, the sector had a P/E multiple of 27.6x, (i.e. a company would need to generate 27 years’ worth of earnings to justify its share price). Although this fell to 23.3x in Q1, it has been argued that tech companies still look expensive compared to sector peers.

Are tech stocks therefore looking expensive and, if so, where else can investors look for growth?

Firstly, it must be considered that tech looks expensive because of the opportunities it offers. Investors are paying a premium for potential future growth and outperformance. Growth investing as a concept defines that these companies must carry higher valuations.

There are, though, other growth-heavy sectors that provide an opportunity to invest at lower valuations. The Consumer Discretionary sector, with a P/E valuation of 18.7x, and Communication Services, at 19.9x, look less expensive than tech but still provide exposure to a growth recovery when the global economy gets back to business as usual.

Although the leg down for markets has provided opportunities to invest at lower levels across the board, the question remains of how similar this recession will be to those that came before and therefore how reliable previous experience may be. Taking the global financial crisis as a comparison, the answer is, very.

In the two years through 2008 and 2009 not only did growth outperform value, but protection in the downturn was provided by Health Care, Consumer Staples and Information Tech. Financials were once again hit hard (unsurprising given the cause of the recession), but Utilities (defensive value) fell significantly.

Perhaps more important is what happened over the next four years as markets recovered. In this time growth outperformed value, Tech outperformed Utilities and Consumer Staples lead the way as economies restarted and spending resumed.

Recent history, therefore, tells us that growth has outperformed value consistently. Whilst some growth stocks may look expensive, they have protected assets in the downturn and provide opportunities to invest at lower valuations and participate in the growth story when markets begin a recovery in earnest.

*Bowmore Asset Management Ltd is authorised and regulated by the FCA. Past performance is not a guide to future performance.

Data source: Morningstar
By Owen Moore, Investment Manager at Bowmore Asset Management