Growth Leads Value — For Now

8/3/2009


After a year in which stocks of all stripes were massacred, growth stocks are the clear leaders in 2009. The Russell 1000 Growth Index of large stocks is up 18.9% through July 28, versus a 3.9% gain for the Russell 1000 Value Index.

Russell classifies stocks as growth or value based on two variables: the ratio of stock price to per-share book value and the consensus estimate for long-term earnings growth. While this is a fairly simplistic way to categorize stocks, growth and value indexes often follow very different trajectories. When Wall Street embraces one style, the other is often left by the wayside.

Especially among small and midcap stocks, these style shifts can lead to huge swings in relative performance. The Russell Midcap Growth Index gained 78% in the 24 months ended December 1999, versus 5% for the Midcap Value Index. Small-cap value gained 40% in the two years ended 2001 — a period in which small-cap growth declined 30% and the S&P 500 Index slumped 20%.

Timing swings in style leadership is difficult, but an understanding of the differences between growth and value can help tilt the odds in your favor. Among the points to keep in mind:

Over the long haul, value has outperformed. Since 1994, value has outperformed growth among large, midcap, and small stocks. The spread is greatest among small stocks, with value rising at an annualized rate of 7.9%, versus 3.3% for growth, based on the Russell indexes. Labeling growth and value stocks based solely on price/book value ratios, Morningstar says large value stocks delivered an annualized compound return of 10.7% from 1928 through 2008, versus 8.5% for large growth stocks. Small value stocks gained an annualized 13.4%, compared to 8.7% for small growth.

Our Quadrix® stock-rating system works differently for growth and value stocks. For growth stocks, Quadrix’s Value and Performance scores are particularly effective, as is the Overall score. Among value stocks, Momentum, Value, Quality, and Performance scores are moderately effective, while Overall works well. The Earnings Estimates score, initiated in 2004, works especially well with value stocks.

The growth and value labels used by index providers are somewhat arbitrary. Indexes maintained by Dow Jones, Standard & Poor’s, Morningstar, and Russell all employ different methodologies. The price/book value ratio, used in all four methodologies, can be a misleading gauge of value and tends to favor some sectors consistently.

There is no reason to choose between growth and value. The best stocks offer both cheap valuations and attractive growth prospects. Quadrix does a good job at identifying such stocks, using Momentum, Quality, Earnings Estimates, and Performance scores to identify likely growers, while Value scores identify cheap stocks.

Based on Quadrix scores, growth stocks are more attractive today. Among stocks in the Dow Jones U.S. Index of large, midcap, and small stocks, the average growth stock earns a Quadrix Overall score of 67, versus 48 for the average value stock. Large growth stocks earn the best scores, averaging 77 Overall. In eight of the 10 market sectors, growth stocks earn higher average scores than value stocks.

Four of our top stocks are reviewed below.

Although Russell classifies Accenture ($35; ACN) as a growth stock, it also looks cheap. The stock trades at 13 times trailing earnings, below the three-year average of 20.

The consultant and outsourcer still sees pricing pressure. Accenture says clients are still cautious about consulting projects, as reflected in fewer big deals getting done. This trend began to show itself before the economic downturn, possibly presaging a marketwide shift to more outsourcing and less consulting. Accenture already generates 40% of its revenue from outsourcing and should be able to adapt to such a change.

Wall Street anticipates per-share profits will increase 1% in fiscal 2009 ending August and 3% in fiscal 2010, targets Accenture should be able to exceed. With Quadrix Quality, Financial Strength, and Overall scores all ranking in the top 5% of our research universe, Accenture is a Buy and a Long-Term Buy.


Airgas’ ($43; ARG) per-share profits fell 19% to $0.66 per share in the June quarter but beat the consensus by a penny. Revenue fell 12% to $979 million. Same-store sales fell 17%, with the hardgoods division down 27%, and revenue from gas and tank rental off 10%. Free cash flow more than doubled to $119 million, helping to fund both debt payoff and a dividend hike.

Airgas, classified as a value stock, also boasts an impressive growth record. Until the recession-stunted March and June quarters, Airgas had increased per-share profits at double-digit rates in every quarter since December 2003. Although higher profits are unlikely in fiscal 2010 ending March, Wall Street expects a 15% jump in fiscal 2011 and double-digit annualized growth over the next five years. At 14 times trailing earnings, the shares trade well below their three-year average P/E ratio of 18. Airgas is a Buy.


BMC Software’s ($34; BMC) products help manage data centers. This market niche has gained importance as data centers have grown larger and more complex. The company has forged partnerships to help it compete against bigger rivals, such as Hewlett-Packard ($42; HPQ) and IBM ($117; IBM). Cisco Systems ($22; CSCO) plans to install BMC’s software on every server it sells, while Dell ($14; DELL) bundles the software with its own servers. Long-term contracts could also help shelter BMC until the economy recovers.

Wall Street predicts per-share earnings will climb 7% in fiscal 2010 ending March and 8% in fiscal 2011. BMC is expected to report June-quarter earnings Aug. 4, with the consensus projecting a 14% surge in per-share profits. The stock offers investors strong growth potential at a reasonable price. Shares trade at 14 times estimated year-ahead earnings, down from a five-year average forward P/E ratio of 20. BMC is a Focus List Buy and a Long-Term Buy.


In the June quarter, NII Holdings ($23; NIHD) earned $0.79 per share excluding special items, down 8% but topping the consensus estimate by $0.22. Revenue slipped 4% to $1.06 billion, dampened by weakness in Latin American currencies. At constant currency, revenue would have risen 19%. Currency woes also weighed on average monthly revenue per handset, which fell 25%.

Further expansion into Brazil boosted the country’s sales nearly 12%, though revenue in Mexico and Argentina fell. NII added 242,100 subscribers in the quarter, continuing its expansion, albeit at a slower pace than that seen in recent years. Shares surged more than 10% on the earnings news.

NII exhibits qualities common to both growth and value stocks. The company ranks in the top 8% of the Quadrix universe as measured by its Quality score, supported by annual sales growth of at least 29% in each of the past five years. The stock also earns a Value score of 95. Wall Street anticipates per-share profits will slip 2% to $2.10 this year, though analyst estimates continue to rise in the wake of the stronger-than-expected quarter. NII Holdings is a Focus List Buy.

YEARLY RETURNS OF RUSSELL INDEXES
—–— Large-Cap —–—
——–— Midcap ——–—
—–— Small-Cap —–—
Year
1000
Index
(%)
1000
Growth
(%)
1000
Value
(%)
Index
(%)
Growth
(%)
Value
(%)
2000
Index
(%)
2000
Growth
(%)
2000
Value
(%)
Style in
Favor
1994
0.4
2.6
(2.0)
(2.1)
(2.2)
(2.1)
(1.8)
(2.4)
(1.5)
Growth
1995
37.8
37.2
38.4
34.5
34.0
34.9
28.5
31.0
25.8
Value
1996
22.5
23.1
21.6
19.0
17.5
20.3
16.5
11.3
21.4
Value
1997
32.9
30.5
35.2
29.0
22.5
34.4
22.4
13.0
31.8
Value
1998
27.0
38.7
15.6
10.1
17.9
5.1
(2.6)
1.2
(6.5)
Growth
1999
20.9
33.2
7.4
18.2
51.3
(0.1)
21.3
43.1
(1.5)
Growth
2000
(7.8)
(22.4)
7.0
8.3
(11.8)
19.2
(3.0)
(22.4)
22.8
Value
2001
(12.5)
(20.4)
(5.6)
(5.6)
(20.2)
2.3
2.5
(9.2)
14.0
Value
2002
(21.7)
(27.9)
(15.5)
(16.2)
(27.4)
(9.6)
(20.5)
(30.3)
(11.4)
Value
2003
29.9
29.8
30.0
40.1
42.7
38.1
47.3
48.5
46.0
Growth
2004
11.4
6.3
16.5
20.2
15.5
23.7
18.3
14.3
22.3
Value
2005
6.3
5.3
7.1
12.7
12.1
12.7
4.6
4.2
4.7
Value
2006
15.5
9.1
22.3
15.3
10.7
20.2
18.4
13.4
23.5
Value
2007
5.8
11.8
(0.2)
5.6
11.4
(1.4)
(1.6)
7.1
(9.8)
Growth
2008
(37.6)
(38.4)
(36.9)
(41.5)
(44.3)
(38.4)
(33.8)
(38.5)
(28.9)
Value
YTD
11.4
18.9
3.9
18.6
24.7
12.2
11.5
19.4
4.4
Growth
Bold indicates best-performing index.

 

RISK AND RETURNS FOR RUSSELL INDEXES
—–— Large-Cap —–—
——–— Midcap ——–—
—–— Small-Cap —–—
1000
Index
(%)
1000
Growth
(%)
1000
Value
(%)
Index
(%)
Growth
(%)
Value
(%)
2000
Index
(%)
2000
Growth
(%)
2000
Value
(%)
YTD Return
11.4
18.9
3.9
18.6
24.7
12.2
11.5
19.4
4.4
1-Year Return
(18.7)
(16.3)
(21.2)
(20.9)
(20.9)
(21.0)
(19.3)
(19.2)
(19.5)
3-Year Return
(6.3)
(2.8)
(9.8)
(6.3)
(4.6)
(8.5)
(6.3)
(3.9)
(8.8)
5-Year Return
0.3
0.8
(0.4)
2.6
2.7
2.0
1.7
2.5
0.8
10-Year Return
(1.1)
(3.5)
0.6
4.0
0.8
5.0
3.5
0.1
6.3
Best 1 Month
10.1
12.7
12.2
15.4
21.0
16.7
16.5
23.3
15.9
Best 3 Months
26.4
26.7
27.6
31.4
42.0
31.2
29.6
43.7
28.9
Best 12 Months
50.3
51.8
48.8
52.3
86.9
51.9
64.4
84.1
64.5
Worst 1 Month
(17.5)
(17.6)
(17.3)
(22.4)
(22.0)
(22.8)
(20.8)
(23.1)
(20.0)
Worst 3 Months
(31.0)
(32.9)
(28.9)
(38.8)
(40.6)
(36.9)
(35.7)
(39.0)
(32.6)
Worst 12 Months
(43.6)
(45.6)
(47.4)
(46.6)
(51.8)
(47.7)
(42.4)
(42.6)
(43.0)
Standard Deviation
17.0
16.8
16.2
20.0
19.6
18.1
22.2
21.0
17.1

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