09 Jan The Tell: Why growth vs. value is all about FAANGs
Investors who think choosing value or growth stocks in 2018 is simply a bet on competing investing styles may be fooling themselves. Instead, either approach will find investors making a concentrated bet on certain sectors, says one well-known Wall Street analyst.
Popular growth and value indexes have pretty much nothing in common. Rather, in the case of growth, they are concentrated bets on the technology and healthcare sectors, while value is a bet on financials and energy, according to Nicholas Colas, co-founder of DataTrek Research.
Value investing is a strategy of choosing stocks whose prices have fallen below their intrinsic value. The idea is to invest in companies that are unloved but have a potential to improve — at which point the market will catch up to price them correctly.
Growth strategy would entail investing in companies which are able to grow their earnings at an higher-than-average rate, providing support for the rising and/or expensive prices.
“Value and growth as a strategy is no longer a useful concept. If you look at the composition of these indexes you will realize that it’s one set of concentrated industries versus another set,” Colas said.
For example, technology stocks, especially so-called FAANG companies: Facebook Inc., Apple Inc. Amazon.com Inc., Google parent Alphabet Inc. and Netflix Inc. NFLX, +0.98% , make up a substantial portion of the growth-oriented funds.
Among large-cap stocks, technology, health care, consumer cyclicals and industrials comprised nearly three quarters of the S&P 500 growth index, according to Colas.
“The tech sector alone accounted for 41% of the S&P 500 growth index, while the top five companies by weight were Apple Inc. AAPL, -0.37% (7.4%), Microsoft Corp. MSFT, +0.10% (5.6%), Alphabet Inc. GOOGL, +0.35% (5.6%), Amazon.com Inc. AMZN, +1.44% (4.1%), and Facebook Inc. FB, +0.77% (3.7%) for a total of 27% of the index,” Colas wrote in a note on Monday.
These companies gained between 35% and 56% in 2017 alone and have not shown any signs of a slowdown so far this year.
Such composition explains why growth outperformed value in 2017. S&P 500 growth stocks rose 27%, while value was up a mere 15%. If you combine the indexes, you get the benchmark S&P 500 SPX, +0.17% , which unsurprisingly gained roughly the average of the two: More than 20% on a total return basis.
By contrast, tech stocks represent only 7% of the S&P 500 value index.
More than half of the S&P 500 value index is concentrated among four sectors: financials (24%), energy (12%), consumer noncyclicals (11%) and industrials (10%). The top five companies also account for only 14% of the value index, according to Colas.
When it comes to small-cap value and growth indexes, the picture is different, however.
The technology sector has a healthier weight of 23%, and comes in just behind the health-care sector at 24%, while industrials comprise 18%. Unlike the way megastocks dominate large-cap indexes, no single name has more than a 0.8% weighting, according to Colas.
In small-cap value, financials have the largest weighting at 28%, followed by real estate and industrials, both at 12%.
“Value as an investing strategy was popularized in the 1970-80s by the fund management industry. It was nothing more than a marketing tool. It is surprising that about 10% of all ETFs or fund managers controlling about $300 billion of assets still adhere to these strategies,” Colas said.
However, dismissing value and only investing in growth has its own pitfalls, considering such a high concentration in technology companies, according to Colas.
The data show that “both approaches lead to portfolios that dramatically overweight some sectors and leave other notable ones with dangerous underweights versus a style-neutral approach. That pushes portfolio managers into taking unnecessary risk just to stay in their ‘style box’ without any observable benefit to asset owners,” Colas concluded.