Value Or Growth? We Like Both

11/17/2014


One newsletter story cannot definitively answer the longstanding question: Growth or value?

Still, our review of the stocks in the S&P 1500 Pure Growth and Pure Value indexes offers some fresh perspective on the topic. Plenty of academic studies — as well as our own work — have suggested that over time, value stocks tend to beat growth stocks.

One of the better-known studies, a Morningstar analysis of stock returns starting in 1926, shows value (measured by price/book ratios) strongly outperformed growth for both large and small stocks. However, over the last 15 years or so, growth stocks have led the way among large-caps, while value dominated with smaller stocks.

Growth's resurgence is also reflected in the returns of the S&P 1500 Pure Growth and Pure Value indexes. As the charts below illustrate, the S&P 1500 Pure Growth Index has outgained the Pure Value Index over the last five and 10 years, and since mid-1995, when S&P's back-tested data on the style indexes begins.

More importantly, both the pure growth and pure value indexes, which contain about one-fourth of the index's market capitalization apiece, have outperformed the broad index. This suggests you can earn market-beating returns with either growth or value stocks.

S&P's pure growth and pure value indexes are designed to feature only stocks with the strongest growth or value characteristics. These indexes exclude about half of their parent index, mostly stocks that don't fit cleanly into one style.

In our Quadrix stock-rating system, growth stocks average higher Overall scores than value stocks (see the table below for details). Not surprisingly, stocks in the pure value index pay higher yields, earn higher Value scores, and trade at lower valuations. In contrast, growth stocks earn higher Momentum scores, look more expensive, and are less likely to pay dividends.

GROWTH VERSUS VALUE
At the moment, growth stocks earn higher Quadrix Overall scores than value stocks, though we still find appealing options in both camps.
------ Average For Stocks In ------
S&P 1500
Pure
Growth
S&P 1500
Pure
Value
S&P 1500
Index
Quadrix scores
Momentum
61
48
54
Value
52
71
56
Quality
77
52
63
Financial Strength
66
48
58
Earnings Estimates
50
46
49
Performance
55
56
57
Overall
66
61
60
Market value
Stock-market value ($bil.)
13.9
14.3
14.5
Dividend yield (%)
0.8
1.7
1.5
% of dividend payers
52
74
67
Total return
3 months (%)
5
4
5
6 months (%)
7
4
7
3 years (annualized) (%)
31
14
20
5 years (annualized) (%)
25
10
16
Value factors
Price/book
4.0
1.6
3.1
Price/earnings
25
19
24
Price/sales
3
1
2.4
Growth factors
3-yr. annual. sales growth (%)
14
4
7
3-yr. chg. in P/E ratio (%)
17
29
24
12-mo. price change (%)
10
9
11

One of the growth factors (change in P/E ratio) doesn't make sense at first blush. S&P's model considers a widening P/E ratio a sign of a growth stock, but the current index components show bigger growth from the value stocks. However, the S&P rebalances these indexes in December, and about 11 months ago the stocks in the Pure Growth portfolio had seen greater P/E expansion. In the intervening months, some of the pricier stocks got cheaper while the values became more expensive, a typical reversion to the mean.

Value stocks have lower average three- and five-year trailing returns, which makes sense when you consider that low returns can lead to lower valuations.

Our growth-at-a-good-price approach gets us into stocks on both sides of the fence, as illustrated in the table below. Using a variant on Standard & Poor's methodology, we slotted our recommended stocks into our own version of the Pure Growth and Pure Value portfolios. In the following paragraphs we review two favorites from each group. Another pure growth stock, F5 Networks ($126; FFIV), is profiled in Analysts' Choice.

Gilead Sciences ($107; GILD) trades at a higher price/sales and price/book ratio than any other stock on our recommended lists. However, there are reasons for that priciness. Powered by its blockbuster hepatitis C drug Sovaldi, Gilead has nearly doubled its sales and more than tripled per-share profits and operating cash flows over the last year. The consensus pr


ojects profit growth of 61% over the next year and 30% annually over the next five. While Gilead's valuation keeps it off the Buy List, growth has earned it a spot on the Long-Term Buy List.

Skyworks Solutions ($61; SWKS) earned $1.12 per share, up 75% and $0.04 above the consensus, in the September quarter. Revenue jumped 51% and operating cash flow 55%. The company projected higher-than-expected sales and profits for the December quarter. Profit margins rose in the quarter, and Skyworks expects substantially higher margins going forward, driven by a shift toward more complex — and profitable — products, as well as strong demand for connectivity from both technology and industrial clients. Skyworks also raised its quarterly dividend 18% to $0.13 per share, payable Dec. 11. Skyworks, yielding 0.9%, is a Buy and a Long-Term Buy.

Value stocks

Big banks like J.P. Morgan Chase ($61; JPM) typically trade at a discount to the broader market. But J.P. Morgan's price/earnings ratio of 11 and price/sales ratio of 2.3 are both at least 15% below the industry median. The consensus projects per-share-profit growth of 7% for the December quarter and 9% next year, targets J.P. Morgan should reach (and possibly exceed) if the economy continues its steady improvement. The stock, which yields 2.6%, is a Long-Term Buy.


At 12 times trailing earnings, ManpowerGroup ($67; MAN) trades 42% below the median for S&P 1500 human-resources & employment-services stocks, as well as 47% below its own five-year average. Manpower's Quadrix Value score of 95, highest among human-resources companies in the S&P 1500 Industry, reflects scores above 50 (in the cheapest half of our research universe) for 90% of our Quadrix Value factors. Economic weakness in France (Manpower's largest market) has weighed on growth in recent quarters, and currency headwinds dragged down the company's December-quarter guidance. However, the 2015 profit-growth target of 5% seems overly pessimistic, and a quarter or two of better-than-expected results could drive valuation multiples higher. Manpower is a Focus List Buy and a Long-Term Buy.

ATTRACTIVE GROWTH AND VALUE STOCKS
The growth and value factors presented below earn stocks their places in Pure Growth or Pure Value indexes. Standard & Poor's rebalances once a year, in December, and many of the stocks currently in an index wouldn't qualify today. Instead of listing current components, many of which will fall out of the indexes next month, we used S&P's methodology to identify buy-rated stocks that might make Pure Growth or Pure Value indexes today.
------ Value Factors ------
----- Growth Factors -----
------------- Quadrix Scores -------------
Company (Price; Ticker)
Stock-
Market
Value
($Bil.)
Div.
Yield
(%)
Price/
Book
Price/
Earnings
Price/
Sales
3-Year
Annual.
Sales
Growth
(%)
3-Year
Chg. In
P/E
Ratio
(%)
12-Month
Price
Change
(%)
Momen-
tum
Value
Quality
Overall
Pure Growth stocks
Apple ($111; AAPL)
664.4
1.7
6.0
17
3.6
22
27
48
88
70
98
99
Aetna ($85; AET)
30.2
1.1
2.0
12
0.5
22
55
33
65
85
83
92
Alaska Air Group
($56; ALK)
7.6
0.9
3.4
15
1.5
10
60
53
95
76
97
100
Ameriprise Fin'l
($130; AMP)
25.2
1.8
3.1
16
2.1
15
99
26
74
70
89
95
CVS Health ($89; CVS)
103.9
1.2
2.7
20
0.8
15
31
40
66
48
78
76
F5 Networks
($126; FFIV)
9.4
0.0
6.8
23
5.4
17
(39)
53
86
52
96
96
Gilead Sciences
($107; GILD)
174.7
0.0
12.9
17
8.4
35
56
60
99
61
99
97
Jones Lang LaSalle
($141; JLL)
6.4
0.4
2.8
18
1.2
14
20
50
99
64
92
98
Kroger ($58; KR)
28.7
1.3
5.7
19
0.3
13
60
40
59
57
79
82
Lear ($92; LEA)
7.5
0.9
2.4
12
0.4
18
55
18
77
90
91
97
Lam Research
($79; LRCX)
14.0
0.9
2.9
17
2.9
3
109
52
94
63
90
97
Shire ($102; SHPG)
39.6
0.3
6.1
20
6.9
13
(14)
49
98
50
99
95
Skyworks Solut.
($62; SWKS)
11.8
0.7
4.7
19
5.2
17
49
142
99
36
98
94
UGI ($38; UGI)
6.7
2.3
2.4
19
0.8
10
30
40
88
61
46
75
Union Pacific
($121; UNP)
108.3
1.7
5.0
22
4.6
10
37
56
87
37
94
91
Growth stock average 
 
1.1
4.5
18
2.7
16
36
53
85
65
89
93
Pure Value stocks
Halliburton ($53; HAL)
45.5
1.4
2.9
14
1.4
14
18
-3
57
91
92
85
J.P. Morgan Chase
($61; JPM)
229.4
2.6
1.1
11
2.2
(3)
61
13
42
87
68
85
Macy's ($62; M)
22.5
2.0
3.9
15
0.8
8
27
24
66
88
93
91
ManpowerGroup
($67; MAN)
5.5
1.5
1.8
12
0.3
(1)
(8)
-17
52
95
82
80
Magna Int'l ($104; MGA)
22.3
1.5
2.5
12
0.6
13
46
23
91
90
94
97
Travelers ($103; TRV)
34.9
2.1
1.4
10
1.3
9
(34)
17
77
95
76
99
Whiting Petroleum
($57; WLL)
6.8
0.0
1.6
12
2.2
19
12
-11
32
90
80
67
Value stock average 
 
1.4
2.2
13
1.3
10
14
4
55
86
80
82
Note: Quadrix scores are percentile ranks, with 100 the best.

About the style indexes

Standard & Poor's pure growth and pure value indexes each contain about a quarter of a broad index's market capitalization. There are no overlaps — in other words, a stock can only be a part of one index, even if it would qualify for both.

Pure growth indexes consider three factors:

1) Three-year sales-per-share growth.
2) Three-year change in price/earnings ratio.
3) Momentum (12-month price change).

Pure value considers three factors:

1) Price/book value.
2) Price/earnings.
3) Price/sales.

Based on the key stats, each stock receives a growth or value score, and the stocks are weighted in the portfolio based on that score, not their market capitalization.


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