Now could be the time for value stocks to shine for investors

David Flynn SINCE the global financial crisis ended in 2008, growth stocks have significantly outperformed value stocks. Looking further back, however, we see that value stocks outperformed growth stocks for roughly a decade leading up to the end of the global financial crisis.

Value stocks are typically defined as shares that trade at a significant discount to their true value (sometimes known as intrinsic value). Value stocks for example may have a low price-earnings (PE) ratio. (The PE ratio is used by investors to get a sense of the value of a company. It is essentially the ratio of a company’s stock price to the company’s earnings per share). Value stocks are usually those of mature businesses whose stocks have experienced temporary earnings setbacks, or suffered due to political or economic events which have hurt their industry.

Value stocks today can be found in emerging markets, Europe, the UK and commodity stocks.

Growth stocks are shares which are expected to grow at a rate significantly above the market average. In many cases, growth stocks are the shares of relatively new companies — or of companies that have relatively new products.

Sometimes growth stocks can also be considered to be value stocks, however they often trade at higher prices, mainly because investors pay a premium for growth. Many growth companies pay little or no dividend because they tend to invest their profits back into their businesses.

Following on from all this, there are three main types of financial disciplines in investing: value, growth and income investing. Income investing often falls into the value or growth camp. Value investing is where investors focus on value stocks. Growth investing is where investors focus on growth stocks.

Over the very long term, we know value investing outperforms growth investing. There is much debate why that is, but it is probably down to something very simple which the late investor Ben Graham taught us many years ago. “Price is what you pay. Value is what you get.”

Valuation is a measure of the value or worth of a company. Pay a high valuation for something and it takes many more years to get back what you put in. Pay a low valuation for something and it takes less time to get back what you put in.

Risk also comes into it. Backtests going back to the 1800s show us that not only do value stocks outperform growth stocks, they also suffer significantly less downside. (A backtest is a system used to test a trading strategy).

From a statistical standpoint, it is highly unlikely growth investing will continue to be the best financial discipline for investors over the next 10 years. So now is therefore probably a good time for investors to think how this could affect their financial well-being in the future.

Before the dotcom crash of 2000, technology stocks were all the rage. At the time, no-one wanted to hear about tobacco, construction or commodity stocks — all of which turned out to be extraordinary investments over the long term. Warren Buffet, for example, was buying shares in tobacco company Philip Morris, a classic value stock at the time. Over the next two years, Philip Morris rose roughly 200pc while the Nasdaq 100 Technology index dropped roughly 80pc.

Each economic cycle is different so I’m not necessarily advocating tobacco, construction or commodity stocks now — but Buffet’s investment in Philip Morris back then is a great example which should not be forgotten.