Growth vs. Value: What Does It Mean?

Investors often ask us why our tactical recommendations don't include growth and value, the way they do large- and small-capitalization stocks. The simple answer—which we'll discuss more below—is that there are often major differences when it comes to the indexes associated with Growth and Value (uppercase G and V) and the factors/characteristics of growth and value (lowercase g and v), such as stronger long-term earnings growth and high free cash flow yield, respectively.

The main benchmark indexes that track the performance of Growth and Value come from S&P Dow Jones Indices and FTSE Russell. Both the S&P 500^® and the Russell 1000^® indexes are large-cap, while the Russell 2000^® indexes are small-cap. For the purposes of this report, we'll focus on S&P 500 Growth, S&P 500 Value, Russell 1000 Growth, Russell 1000 Value, Russell 2000 Growth, and Russell 2000 Value indexes.

Starting with the Russell family of indexes, you can see in the chart below that performance has looked markedly different when comparing large caps vs. small caps. Whereas Russell 1000 Growth has outperformed Russell 1000 Value by more than 2,500% since the indexes' inception in the late 1970s, Russell 2000 Growth has lagged Russell 2000 Value by 1,700% over the same timeframe.

For investors who were on the hunt for deep value, the clear play from a factor perspective was the beaten-up Tech stocks. Many of the hardest-hit names were indeed trading at deeply undervalued prices, but were still "housed" in the Growth indexes. In fact, at the market's bottom in October 2002, the forward price-to earnings (P/E) ratio¹ of the Tech stocks within the S&P Growth index was 20.5—significantly lower than the 25.6 forward P/E of the Tech stocks within the S&P Value index. In other words, many of the cheapest Tech names were actually found in the Growth index.

Not only did the classification detail matter for finding actual value, it mattered for forward performance. Looking specifically at the biggest casualty in that era, the Nasdaq 100, its members with lower multiples tended to fare better as the new bull market commenced.

At the October 2002 low, the median Nasdaq 100 member's forward P/E was 22.6. Those stocks with forward P/E of less than 22.6 (shown in the blue line the chart below) outperformed the cohort with forward P/E greater than 22.6 (the yellow line) by an average of nearly 200% in the ensuing decade. Thus, screening for the simple value characteristic of a less-expensive forward P/E yielded stronger returns—even in a heavily growth-oriented index.

• Real Estate Investment Trusts, or REITs, the second-worst-performing cohort during the GFC (falling 79%), were trading at an average 15.5 forward P/E in the S&P Growth index vs. an average 25.2 forward P/E in the S&P Value index. (Equity REITs, part of the Financials sector during the GFC, were moved in 2016 to a separate Real Estate sector within the Global Industry Classification Standard, or GICS®.)
• The Consumer Discretionary sector (which fell 61%) was trading at a 14.9 forward P/E in S&P Growth vs. an 18.4 forward P/E in S&P Value.
• The Tech sector (which fell 55%) was trading at a 12.8 forward P/E in S&P Growth vs. a 15.2 forward P/E in S&P Value.

Put another way, many of the less expensive (or value-oriented) members in the REITs, Consumer Discretionary, and Tech areas were housed in the S&P Growth index, not in the S&P Value index—so investors didn't receive much value at all if they blindly bought a Value index without looking specifically for value.

Navigating the landscape from a factor-based approach has yielded less choppiness and more consistency, even in sectors that may not be considered growth- or value-oriented. For example, value factors have performed quite well in the growth-oriented Tech sector. As you can see in the chart below, within the Tech sector, the value factor of high free cash flow yield has outperformed the growth factor of long-term estimated earnings growth by a wide margin since the beginning of 2021 (though that margin has shrunk since the summer of 2022).