Why value beats growth investing

Few issues raise more passion in the investment world than the debate over whether growth or value is the best strategy. Growth investors argue that if you can find a company with the potential to grow both its sales and its profits quickly, then you should snap it up. Value investors argue that future growth is so inherently uncertain that it makes more sense to find companies that are cheap those trading on low multiples of their earnings, for example in the expectation that they will recover.

Growth investors have a point: stocks with fast-growing earnings do tend to do well. If you had put $10,000 into a portfolio of the stocks that were growing their earnings most rapidly in 1990, then it would have been worth $92,600 two decades later, according to Bob Turner of Turner Investments, compared with just $10,400 if you had bought into the slowest-growing stocks. A similar study by McKinsey found that between 1980 and 2012, the market capitalisation of companies with rapidly growing earnings increased by an average of 23% a year.

Growth stocks have also beaten value stocks over the past decade. Passive investment giant Vanguard looks at what would happen if you split the S&P 500 into three equally valued portfolios "growth", "blended" and "value" and rebalanced them once a year. In the past ten years, the growth portfolio returned 8.3% a year, compared with just 5.51% for the value stocks. Similarly, the MSCI World Growth index has returned an average of 5.55% a year, compared with 3.35% for the MSCI World Value index.

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However, while growth may be ahead currently, value has won out over the very long run since 1974, the MSCI World Value index has grown by 11.75% a year, compared with the 9.54% return on the MSCI Growth index. The trouble is, growth fizzles fast.

Louis Chan of the University of Illinois found that between 1951 and 1988, around 25% of listed US companies maintained above-median income growth for two years in a row. But only 3.6% could maintain that performance for five years, and just 0.3% over a decade. Stocks in "growth" sectors fared little better nearly 95% of tech stocks failed to deliver above-average growth for five years in a row. What's more, value stocks also tend to be less volatile than their growth peers, according to fund manager Fidelity.

The good news for long-suffering value investors is that the tide may now be turning. Value has beaten growth by more than 3% over the past year. If you are looking for a broad-based bet on a turnaround, the iShares Edge MSCI World Value Factor ETF (LSE: IWVL) is one value-focused exchange-traded fund.