The Growth/Value Conundrum
Staffing agency Robert Half International ($45; RHI) earns a Quadrix Value score of 76, while its price/earnings ratio of 17 is 14% below the median for commercial & professional services stocks and 25% below the company's own three-year average. Robert Half looks a lot like a value stock, don't you think?
Of course, Robert Half also earns a Momentum score of 68. Per-share profits rose 19% over the last year and are projected to grow 11% in the year ahead and 15% annually over the next five years. Those numbers qualify Robert Half as a growth stock.
So, which label is right?
Both, at least according to Standard & Poor's, which includes the company in the S&P 1500 Growth Index as well as the S&P 1500 Value Index.
Regular readers know we don't favor either growth or value over the other, and in fact prefer to find attractively valued growers, the best of both worlds. That way, we don't fall prey to periods when one investment style dominates the other.
In recent years, growth has held the edge, outperforming over the last one, three, five, 10, and 20 years ended March, as illustrated in the chart below. While growth has outperformed in six of the last eight years ended March, Value outperformed in seven consecutive years before that. Value has beat growth over the last 80-plus years, outperforming in all but one calendar decade from the 1940s through the 2000s.
Why dredge up all that history? To demonstrate that both growth and value are capable of grabbing the lead and holding it for long periods, so you shouldn't hitch your wagon to one or the other.
We can make arguments in favor of either style for the year ahead (below, we do just that), but not with enough confidence to pick just one. At the moment, our Focus List leans toward growth, as shown in the table below. However, we came by this bias not because of an asset-allocation decision, but by selecting individual stocks that satisfied our varied criteria.
Growth stocks don't always dominate. At many times in the past, our top stocks have tilted toward value.
In the following paragraphs, and in Analysts' Choice, we profile Focus List stocks with impressive credentials in both the growth and value camps.
Over the last year, Amerco ($344; UHAL) grew per-share profits 25% and operating cash flow 68%. Analysts expect the growth to continue, calling for a profit gain of 22% over the next four quarters — about what you'd expect from a stock with a Quadrix Momentum score of 96.
Amerco also scores among the top one-third of our Quadrix research universe in Value (68). At 14 times trailing earnings, the stock trades at a 4% discount to its three-year average.
As the largest provider of do-it-yourself moving and storage services in the U.S., Amerco stands to benefit from the formation of new households, as well as Americans' willingness to move when the job market is strong.
Cable giant Comcast ($62; CMCSa) qualifies for both the S&P 1500 Value Index and the S&P 1500 Growth Index. Comcast boosted sales 8% and operating cash flow 11% over the last year, solid growth for such a massive company. For now, investors seem to have set aside their fears of cord-cutting. In the December quarter, Comcast added 89,000 video subscribers, the most in any quarter in eight years — not the picture of a company hamstrung by viewers migrating to nontraditional TV platforms.
While Comcast is best known for pay-TV operations, its film and theme-park units are driving growth, with revenue up 26% and 39%, respectively, in the December quarter. The consensus projects a 2% decline in profits for the March quarter but an 8% gain for the year.
Staffing firm Robert Half International's ($45; RHI) results have been buoyed by two key trends:
• Hiring growth: U.S. nonfarm payrolls swelled by 2.8 million jobs in the year ended March and more than 8 million over the last three years. Against such a backdrop, three-year annualized sales growth of 10% comes as no surprise.Â
• Higher wages: Average hourly earnings rose 2.2% year-over-year in February, up from 1.9% in the same period a year ago. Continued wage growth should boost both the top line and profit margins for Robert Half in coming quarters. The consensus projects sales up 8% and profits 11% this year, followed by growth of 7% and 11%, respectively, in 2017. Assuming continued hiring and modest economic growth, those targets could prove conservative.
Not surprisingly, stocks in the S&P 1500 Value Index are cheaper than those in the growth index. Stocks in the value index trade at an average of 2.0 times trailing sales and 2.5 times trailing book value, both 38% below the average for growth stocks.
Of course, a value index should contain cheaper stocks, and we're equally unsurprised to discover that those value stocks can't match the growth of the stocks in the growth index. Still, we can make three good arguments in favor of value stocks:
1) Value stocks enjoy short-term price momentum. Stocks in the value index have averaged total returns of 10% over the last three months, topping the return of 7% for stocks in the growth index. The top quintile (one-fifth) of stocks as measured by Value score outperformed the typical stock in the S&P 1500 by an average of more than 1.5% in February and March, the strongest two-month stretch since early 2014. Two months does not a trend make, but it's nice to see value stocks doing well.
2) Not only are value stocks cheaper than growth stocks, but they're also cheaper relative to their own historical norms, which isn't always the case. Value stocks trade at an average discount of 7% to their five-year average price/sales ratio and a 5% discount on price/book, while growth stocks trade at a premium to historical norms on both metrics.
3) Less growth doesn't mean no growth. Value stocks' average growth numbers are skewed by energy stocks, which account for 11.5% of the value index, versus just 1.4% of the growth index. Exclude energy stocks, and value index components average profit-growth expectations of 5% over the next year and 11% annually over the next five — not great, but enough to support higher share prices.
Why growth wins in 2016
Growth stocks have ruled for the last eight years, outperforming value in six of the last eight 12-month periods ending March. While past outperformance doesn't guarantee future outperformance, we can make a three-point case for growth stocks without relying on their price momentum in recent years.
1) We view the Quadrix Overall score as a proxy for fundamental strength, and stocks in the S&P 1500 Growth Index average Overall scores of 61, versus 56 for components of the value index. That difference in average may not sound like much, but it reflects a concentration of growth stocks among the top scorers. Nearly 23% of the index's growth stocks earn Overall scores above 80, with 10% above 90. In contrast, 18% of value stocks score above 80 and 7% above 90. It's easier to find high-potential stocks in the growth camp.
2) At the moment, growth stocks hold the edge in the "strong sectors" category. Consumer-discretionary and technology stocks account for nearly half of the growth index's stock-market value, versus less than 20% of the value index. While we don't select stocks because of their sector, in recent months we've found a lot to like in both sectors. Call them target-rich environments. Of the 28 stocks we currently recommend, five are consumer discretionary and seven technology, combining to account for 43% of the total.
3) While value stocks are (not surprisingly) cheaper than growth stocks based on most absolute valuation metrics, we also considered a ratio that takes growth into account. The average growth stock earns a PEG ratio (price/earnings divided by estimated long-term profit growth) of 1.7, slightly below the average of 1.8 for value stocks.