Growth And Value: Two Sides, Same Coin

4/24/2017


So far this year, growth stocks are outperforming value stocks. But that doesn't mean you should go out and buy all growth stocks.

Last year, value beat growth. And over multidecade time periods, value tends to outperform. Which doesn't mean you should go out and buy all value stocks, either.

In the year ended March, the Quadrix Value score worked very well for both growth and value stocks. Companies in the top one-fifth of the Dow Jones U.S. Growth Index as measured by Value score outperformed the average stock in the index by an average of 4.1%, while the same strategy in the Value Index yielded average excess returns of 8.2%.

The Value score's strong showing shouldn't surprise us, given that it has been the most effective category for both growth and value stocks over the last 15 years. Among growth stocks, the Momentum and Earnings Estimates scores — both of which reward growthy characteristics — have also enjoyed solid predictive power over the long haul, though neither worked in the last year.

Quadrix scores haven't historically worked as well for value stocks as they have for growth stocks. However, in the last year, top scorers in Performance did especially well — a shock, given that Performance has been the least-effective category score for Value stocks over time.

At the moment, growth and value stocks earn similar Quadrix Overall scores. See the table below for a comparison of the groups.

GROWTH VERSUS VALUE
All numbers other than the company counts are averages for stocks within the Dow Jones U.S. Index. Not surprisingly, the stocks in the Growth Index have both higher growth rates and higher valuations than stocks in the Value Index. Both groups earn roughly similar Quadrix Overall scores.
Growth
Value
Dow
Jones U.S.
Index
No. of companies
469
556
1,203
Price/earnings ratio
Trailing
25
20
22
On next-yr. profits
22
18
20
Price/book
4.8
2.8
3.6
Price/sales
3.2
2.5
2.8
LT est. profit gro. (%)
15
8
11
Dividend yield (%)
0.7
2.7
1.8
12-month growth
Sales (%)
9
1
5
Earns. per share (%)
9
2
6
5-year annualized growth
Sales (%)
11
2
6
Earns. per share (%)
12
3
7
Quadrix scores
Momentum
54
51
52
Value
48
59
55
Quality
70
54
62
Financial Strength
57
55
56
Earnings Estimates
50
53
52
Performance
50
52
51
Overall
58
57
58
Notes: Averages may exclude some outliers.    Quadrix scores are percentile ranks, with 100 the best.

While the divergence in Value and Quality scores makes sense, the average growth stock's Momentum score of 54 is not much higher than the average of 51 for value stocks. We'd expect a wider spread for Momentum, which considers mostly the growth of operating statistics over the last quarter or year.

However, while growth stocks look attractive relative to historical norms based on valuation ratios, they aren't growing as fast as they usually do (long-term average Momentum score of 57). At the same time, value stocks earn higher Momentum scores than their own long-run average of 47. The opposite trend applies with Value scores, as growth stocks are somewhat cheaper and value stocks somewhat more expensive than usual.

While both growth and value stocks seem to be sliding toward the middle, we remain comfortable fishing in both ponds. As the table below shows, we gravitate toward growth stocks with reasonable valuations and value stocks that will deliver some growth. Below we profile two of our favorites from each group:

Growth stocks

Lam Research ($136; LRCX), a maker of semiconductor equipment, has certainly earned its label as a growth stock. In the March quarter, reviewed on page 7, per-share earnings rose 137% on a 64% sales gain.

The proliferation of wireless devices in recent years has boosted demand for semiconductors that can pack more and more memory into a tight space. Lam is well-positioned to take advantage of the ongoing shift to denser memory chips. Such demand trends explain why analysts expect profits to increase at an annual rate of 15% over the next five years.

In our view, Lam's valuation doesn't adequately reflect its growth potential. The shares trade at just 14 times expected year-ahead earnings, 43% below the industry average. Lam, yielding 1.3%, is a Focus List Buy and a Long-Term Buy.


Shares of Southwest Airlines ($55; LUV) — and other airlines — have lost altitude over the last six weeks. Even though Southwest stock has bounced 5% from its March 21 trough, it remains down 7% from its all-time high of $58.88 per share, set March 1.

The company earns a Quadrix Value score of 83. Southwest isn't cheap relative to its peers, but don't let that scare you off. The company has commanded a premium for years, in part because of its ability to generate profit growth more consistently than other airlines. The consensus calls for an earnings gain of just 1% this year despite 5% revenue growth, reflecting expected increases in fuel and salary expenses. Analysts project a return to growth in 2018, with per-share profits up 21%. Southwest is a Focus List Buy and a Long-Term Buy.

Value stocks

Investors don't normally think of stocks like CommScope ($41; COMM) as value selections, but the numbers don't lie. CommScope, which makes telecom-networking products, earns a Value score of 73, well above the average of 59 for communications-equipment companies in the S&P 1500. The shares trade for 16 times trailing earnings and 14 times expected profits for 2017.

CommScope makes antennas and cables used in wireless towers. The consensus projects profit growth of 12% this year and 11% next year, estimates that could prove conservative if the Trump administration succeeds in its plans to boost infrastructure spending. But even if the new spending proves elusive, CommScope's blend of value and growth earns it a Buy and Long-Term Buy rating.


Homebuilder D.R. Horton ($34; DHI) has recovered nicely from last year's ugly decline. So far this year, the shares have risen 24%. Despite those gains, they remain appealingly priced at 14 times trailing earnings, 26% below their five-year average.

Over the last eight quarters, D.R. Horton averaged sales growth of 21% and per-share-profit growth of 29%. Such torrid growth can't continue, but the consensus calls for sales to rise 14% this year and 10% next year, along with profit increases of 16% and 10%, respectively. The 2018 profit target reflects concerns that higher interest rates will crimp mortgage demand. However, with mortgage rates historically low, it might take more than a year for costs to deter new buyers in large numbers, which suggests upside to the consensus profit target. D.R. Horton is a Buy and a Long-Term Buy.

BLENDING GROWTH AND VALUE
Among our recommended stocks, 13 are part of the Dow Jones U.S. Value Index, while 15 are part of the Growth Index. Most of our stocks have both value and growth characteristics, with our growth stocks averaging Quadrix Value scores of 66, while our Value stocks average 74 in Momentum. In an effort to obtain both value and growth, we limited this table to value stocks with Momentum scores of at least 60 and growth stocks with Value scores of at least 60. Quadrix scores are percentile ranks, with 100 the best and 0 the worst.
Price/Earnings
------- Ratio -------
LT Est.
Profit
Growth
(%)
Growth, Last
--- 12 Months ---
Growth, Last 5
Years (Annual.)
------------- Quadrix Scores -------------
Company (Price; Ticker)
Div.
Yield
(%)
Trailing
On Next-
Year
Profits
Sales
(%)
Earnings
Per Share
(%)
Sales
(%)
Earnings
Per Share
(%)
Momen-
tum
Value
Quality
Overall
Value stocks
Amgen ($161; AMGN)
2.9
14
13
7
6
13
8
16
82
81
95
91
Applied Materials
($39; AMAT)
1.0
18
15
19
24
75
3
10
99
70
92
99
CDW ($58; CDW)
1.1
17
15
8
8
23
8
24
92
69
93
95
Citizens Financial
($34; CFG)
1.6
18
15
16
9
22
6
10
94
81
67
98
CommScope
($41; COMM)
0.0
16
14
7
29
152
8
NA
70
73
86
93
D.R. Horton
($34; DHI)
1.2
14
12
10
16
20
27
45
74
86
96
97
Foot Locker
($73; FL)
1.7
15
13
10
5
12
7
21
67
85
95
93
Lear ($137; LEA)
1.5
10
9
9
2
30
6
23
83
98
95
99
Synchrony Financial
($33; SYF)
1.6
12
11
9
11
2
9
2
64
95
68
88
Zions Bancorp
($40; ZION)
0.8
20
16
12
13
64
(2)
19
91
76
64
95
Growth stocks
Apple ($141; AAPL)
1.6
17
16
9
(7)
(11)
11
11
32
61
90
79
Centene ($72; CNC)
0.0
17
15
13
78
29
50
28
89
94
90
98
Citrix Systems
($83; CTXS)
0.0
16
18
11
4
64
9
16
48
73
93
88
F5 Networks
($136; FFIV)
0.0
18
16
12
4
11
11
13
60
67
94
85
FedEx ($184; FDX)
0.9
16
15
14
16
40
6
4
59
72
76
81
LabCorp of America
($143; LH)
0.0
16
15
10
11
11
12
6
52
78
76
82
Lam Research
($136; LRCX)
1.3
19
15
15
24
55
22
25
91
62
93
97
Lowe's ($82; LOW)
1.7
21
18
15
10
21
5
23
86
70
95
96
Mohawk Industries
($234; MHK)
0.0
19
18
9
11
23
10
35
76
67
96
94
Southwest Airlines
($55; LUV)
0.7
15
14
11
4
4
5
58
55
83
98
91
NA Not available.

 


Growth or value?

Even if you prefer one style of investing over the other, sometimes it's not easy to determine whether a stock qualifies as growth or value. Plenty of stocks seem to satisfy both criteria, while some don't look good from either angle.

The Dow Jones U.S. Index, which we used for the story above, relies on six statistics to slot stocks into growth, value, or neutral territory:

1) P/E on estimated profits for the next year.

2) Long-term estimated profit growth.

3) Price/book ratio.

4) Dividend yield.

5) Sales growth over the last five years.

6) Earnings growth over roughly the last five years.

Three of the six statistics focus on valuation, three on growth. Other index providers use different criteria, and for the most part, all the criteria are logical. The Dow Jones U.S. Index assigns Forecasts recommendations Centene ($72; CNC), LabCorp of America ($143; LH), and Lowe's ($82; LOW) — all of which earn solid Quadrix Value scores — to its growth index. At the same time, the S&P 1500 Index considers them value stocks.

In our view, rather than focusing solely on growth or value, investors should seek out stocks that offer both, like the ones in the table above.


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