There are many ways to pick stocks to your portfolio, but two main categories that stocks can be subdivided into are growth stocks and value stocks. Growth stocks are considered those that have the potential to outperform the market over the long run due to their future potential, while value stocks are stocks that are currently undervalued and can yield higher returns. While the value approach is often advocated as the safest way to invest in stocks and benefit from long-term returns, in the bull run since 2009, growth stocks have “mopped the floor” with value stocks, although from time to time, especially when tech stocks see a sell-off, Wall Street starts to buzz about a turnaround.
This has been particularly tough on big value investors, like David Einhorn‘s Greenlight Capital, which lost more than 10% between 2014 and the end of last year, sustaining losses of 20% in 2015. In 2017, Greenlight returned 1.7%, which was significantly below the S&P 500’s gain of 21.8%. Last month, Greenlight lost another 6.6% (its worst monthly performance since October 2008) as its long positions inched up unsignificantly, but its short bets surged. General Motors Company (NYSE:GM), which is Greenlight’s top holding, according to its third-quarter 13F, has appreciated by 3.50%. AerCap Holdings N.V. (NYSE:AER) ended the month 2.83% in the green. Brighthouse Financial Inc (NASDAQ:BHF), in which Greenlight acquired a stake after it was spun off from Metlife Inc (NYSE:MET), advanced by 9.60%.
In this way, Greenlight’s long bets all made money during the first month of the year, but the gains are unsubstantial compared to losses sustained in its “short basket”, which includes Amazon.com, Inc. (NASDAQ:AMZN), Tesla Inc (NASDAQ:TSLA), Netflix, Inc. (NASDAQ:NFLX), and athenahealth, Inc (NASDAQ:ATHN). Among these stocks, Amazon.com, Inc. (NASDAQ:AMZN) and Netflix, Inc. (NASDAQ:NFLX) surged by 24% and 40.80%, respectively, while Tesla Inc (NASDAQ:TSLA) grew by 13.8%. athenahealth, Inc (NASDAQ:ATHN) is the only stock that declined in the first month of 2018, by 5.81%.
In a note to clients, Greenlight pointed out that during the first month, its long portfolio “achieved about half the S&P 500 return,” and its short bets “went up by more than twice the index.”
One of the reasons why Greenlight’s returns have been lagging is that the fund stuck to its value investing approach and kept betting against high-growth tech stocks like Amazon.com, Inc. (NASDAQ:AMZN) and Netflix, Inc. (NASDAQ:NFLX). In its letter to investors for the fourth quarter of 2016, Greenlight said that Netflix, Inc. (NASDAQ:NFLX) deserves to be in its short basked “because its domestic market has matured; it risks an unfavorable change in net neutrality rules; and it has not demonstrated that its huge investment in original content has a positive return. […] NFLX is able to report that its U.S. streaming segment is highly profitable only by allocating a disproportionate amount of content amortization to its smaller and unprofitable international streaming segment.”
Greenlight has also been shorting Amazon since at least 2014. In the third-quarter letter for that year, the fund said Amazon.com, Inc. (NASDAQ:AMZN) is one of the stocks that will prove false the narrative that it “is growing too fast to be very profitable” that is often used to support bubble stocks.
Nevertheless, both Amazon.com, Inc. (NASDAQ:AMZN) and Netflix, Inc. (NASDAQ:NFLX) have skyrocketed as the overall investor sentiment towards these stocks remained strong.
Einhorn is convinced that his value approach will pay out. “While we certainly don’t believe value investing is dead, it is clearly out of favor at the moment. […] While it feels like we have been running face first into the wind, we don’t intend to capitulate and are sticking to our strategy of being long misunderstood value and shorting “not value.””
So, is Einhorn and other value investors right to stick to their guns? Since the beginning of the bull market in March 2009, growth stocks have outperformed value stocks. The iShares S&P 500 Value Index (ETF) (NYSEARCA:IVE), which tracks the S&P 500 Value Index and has its largest holdings in Berkshire Hathaway Inc. (NYSE:BRK.B), JPMorgan Chase & Co. (NYSE:JPM), and Exxon Mobil Corporation (NYSE:XOM), has surged by 227% since March 2009. By comparison, iShares S&P 500 Growth Index (ETF) (NYSEARCA:IVW) that incorporates Apple Inc. (NASDAQ:AAPL), Microsoft Corporation (NASDAQ:MSFT), and Amazon.com, Inc. (NASDAQ:AMZN) among its top holdings, has advanced by 302.62%.
One of the reasons why value stocks have underperformed growth stocks is that since the recession, the economic growth has been relatively slow, with many developed countries registering inflation below targets and investors chose to invest in companies that have potential to grow rather than those that look undervalued.
However, if we look closer at growth and value stocks, we can see a different situation. The tricky bit about growth and value stocks is that often companies exhibit characteristics of both. For example, General Electric Company (NYSE:GE) is part of both IVE and IVW ETFs. Apple Inc (NASDAQ:AAPL), while is viewed by many as a “go-to” growth stock is included in both growth and value ETFs and value investors like Einhorn and Buffett are bullish on the stock. Luckily, there are many “pure” growth or value ETFs as well, which focus solely on each of the two investment styles.
Let’s take a look at two funds from Guggenheim. Guggenheim S&P 500 Pure Growth ETF (NYSEARCA:RPG) takes into account traditional growth fundamentals like sales and earnings growth, and price momentum, while Guggenheim S&P 500 Pure Value ETF (NYSEARCA:RPV) includes a value basket that is based on traditional value fundamentals, such as price/book ratio, sales/price ratio, and earnings price/ratio (Guggenheim also has a blended basket that includes stocks with both growth and value characteristics). In the last three years, Guggenheim Invest S&P 500 Pure Value ETF (NYSEARCA:RPV) underperformed Guggenheim S&P 500 Pure Growth ETF (NYSEARCA:RPG) 21% to 36%. However, since March 2009, Guggenheim Invest S&P 500 Pure Value ETF (NYSEARCA:RPV) is up by 534%, while Guggenheim S&P 500 Pure Growth ETF (NYSEARCA:RPG) has gained 446%. So, pure growth stocks seem to underperform pure value stocks over the long run, which is in line with empirical research on the subject.
In 2017, value stocks also underperformed value stocks, but 2018 might be the year when the situation changes. Companies are maintaining their earnings momentum as economic growth doesn’t show any signs of slowdown and favorable environment should aid value stocks. Moreover, as the Fed intends to tighten monetary policy, higher interest rates might hurt growth stocks, while helping many banking companies that are generally perceived as value stocks. Oil and gas industry, another component of value indexes, is also expected to recover in 2018. Finally, there are concerns that the market is overheated, and growth stocks that had several years of sustained growth are poised to fall harder if the market turns south, which can result in investors’ sentiment switching towards value stocks.
Disclosure: none
