Asset Management

Growth and Value: A Matter of Style

Susan Hirsch, Managing Director and Lead Portfolio Manager of TIAA-CREF's Large-Cap Growth
Richard Cutler, Managing Director and Portfolio Manager of TIAA-CREF's Large-Cap Value Fund

September 19, 2012

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Large-cap growth and value are two distinct – and complementary – approaches to investing in the stock market. Large-cap growth investors look for stocks with rising share prices and strong growth potential. In contrast, large-cap value investors look for stocks at low prices relative to the company’s intrinsic long-term value, which the investor believes has the potential to be unlocked. Many individual investors blend these styles in the context of their asset allocation plan, typically by owning a value fund and a growth fund in their overall portfolios. When used in combination, large-cap growth and value investing can enhance a portfolio’s overall diversification strategy, thus increasing total return potential and reducing volatility.

Susan Hirsch, Lead Portfolio Manager of TIAA-CREF’s Large-Cap Growth Fund, and Richard Cutler, Lead Portfolio Manager of TIAA-CREF’s Large-Cap Value Fund, answer some questions about growth and value investing.

Article Highlights

  • Large-cap growth investing focuses on the stocks of expanding businesses.
  • Large-cap value investing seeks out-of-favor stocks at low prices.
  • Large-cap growth and value stocks tend to perform differently at different times.
  • As a result, holding both kinds of stocks may potentially increase a portfolio’s total return and reduce its volatility.

What are growth and value stocks?
Large-cap value stocks may have compelling intrinsic value and long-term appreciation potential, but are temporarily out of favor or less well-known (i.e., “under the radar” of most Wall Street analysts), and may therefore be priced at a discount. Large-cap value investors expect to profit over the long term as the market gradually recognizes the company’s true worth and the stock price rises. In addition, a large-cap value company often returns some of its profits to shareholders in the form of dividends or stock buybacks. Large-cap value stocks can be found in all industry sectors.

In contrast, large-cap growth companies, which thrive on innovation and change, can mature into market-leading, nationally recognized enterprises. Investors are often willing to pay a premium for these high-quality companies because of their exceptional growth potential. These companies generally reinvest cash flow from operations into new growth initiatives in order to maintain above-average growth rates; as a result, most do not pay large dividends. Instead, investors are rewarded by the company’s growth if the initiatives are successful: New products or services may support higher profits, which equate to higher share prices in the long term. Although growth stocks can also be found in all industry sectors, the ones that exhibit the most growth characteristics are those that rely on innovation and change for growth, including technology, healthcare and consumer discretionary (which includes retailers, media companies and apparel companies).

Why does it make sense to invest in both growth and value stocks?

Holding both large-cap growth and value stocks simultaneously increases a portfolio’s overall diversification, thus increasing return potential and reducing volatility. Historically, large-cap growth and large-cap value stocks have tended to perform differently at different times, as illustrated by the Russell 1000 Growth and Value indexes (see Exhibit 1).

Since 1995, for example, growth stocks have generally fared better when market volatility has been low—as in 1999, during the boom in technology stocks. In that year, large-cap growth stocks surged 33.16%, while large-cap value stocks rose just 7.35%. In contrast, when market volatility has been high, value stocks have generally outperformed. For example, in 2000, after the tech bubble burst, large-cap value stocks gained 7.01%, strongly outperforming large-cap growth stocks, which declined 22.42%.

Russel Graph
(Past performance is no guarantee of future results.)

During periods of extreme global market volatility—such as the financial crisis and recession of 2008 and early 2009—large-cap growth and large-cap value stocks may be more likely to rise and fall in tandem. In 2008, for example, the Russell 1000 Growth and Russell 100 Value Indexes posted similar returns of -38.44 and -36.85%, respectively.

What are some of the common myths or misperceptions about growth and value investing?
One of the common myths or misperceptions about value investing is that stocks are likely to be low-quality industrial companies. But in fact, there are many high-quality value companies in sectors such as technology and biotech, which have simply fallen out of favor for economic or cyclical reasons. This gives us the opportunity to buy world-class, blue-chip companies at very reasonable prices.

There are also common misperceptions about investing in growth stocks—for example, that large-cap growth stocks always grow. In fact, even high-quality growth companies can go through growing pains if a new product or service does not do as well as planned or if the company misses a new product introduction. When that happens, growth expectations disappoint and growth companies may lose their premium value. This may be a good time for investors to get interested. Of course, there is no guarantee that any company will rebound or continue to grow.

How has the globalization of economies and markets affected growth and value investing?
As a result of such globalization, it has become apparent that certain global sectors such as oil and gas move in correlation through stock market fluctuations. As we evaluate companies in the value space, this affords us the opportunity to buy fast-growing, high-quality companies at a discount prices when all of the companies in a particular sector are under pressure at the same time.

For growth stocks, the globalization of economies and markets has created opportunity in two ways. First, U.S. companies have been able to capitalize on opportunities overseas: As domestic unemployment numbers remain high and consumers curtail their spending habits, U.S. companies have made the burgeoning middle classes in emerging markets such as India and China a critical part of their strategies, building their brands and franchises overseas in search of greater profits. Second, overseas growth stocks offer a critical source of diversification in growth portfolios, allowing investors to capitalize on growth trends in a wide variety of markets.

Is there any overlap of companies in large-cap growth and large-cap value investing?

In depressed economic cycles, it is common for the same stocks to meet the criteria of both our growth and value funds, and in the current economic climate, there is more overlap than ever before between companies that we invest in for the large-cap growth and value portfolios. For example, the large-cap value portfolio invests in some of the same companies held in the large-cap growth portfolio because a particular company may have had some recent adverse news that brought down its share price and it is now perceived to be undervalued. Exhibit 2 shows the number of holdings and duplicate companies in the Russell 1000 large-cap growth and Russell 1000 large-cap value indices from December 2004 to June 2012.

Growth and Value Indices

Are there any issues that could have an impact on large-cap growth or value stocks?
In the value space, we need to look at stocks’ current valuations and consider whether they will achieve their earnings potential. This can be tricky in the near term. But over the longer term, we are willing to deal with short-term pain to find companies that are “cheap” based on normalized earnings, which are averaged over a cycle.

Meanwhile, in the growth space, a lot of large-cap growth stocks with high price multiples are feeling the pinch of slower growth. Investors usually pay a premium for these stocks with the expectation that growth will continue. In today’s slow growth environment, however, investors are not willing to pay a high premium because the economic climate is too risky. The impact on growth stocks is that there is a shift to mega caps stocks with market caps of over $100 billion, where investors anticipate more modest growth, and secular stocks, in which investors are confident that growth will be sustained. In addition, growth portfolios will focus on companies with greater U.S. exposure so that European woes will not be as painful and government policy in China and elsewhere will have a less pronounced impact.

What are the short-term and long-term outlooks for large-cap growth and value stocks?
In the large-cap value space, there is a huge disparity right now between safer yielding stocks and riskier lower-valuation stocks. For example, the price valuations of lower-risk utility stocks are very expensive, while higher-risk financial stocks have lower price valuations. In essence, it’s really a balancing act between risk and earnings visibility. There are a lot of opportunities in the short term because there are many inexpensively priced stocks. Over the long term, we believe that accurate price valuations hold the key to generating better returns than the benchmark.

For large-cap growth stocks, the ideal environment is a moderately expanding economy and subdued interest rates. In that environment, the competitive landscape for returns comparable to what growth stocks can provide is limited. Thus, an investment in a company hypothetically growing at 15%-20% can provide an overall return to investors of a similar amount—assuming nothing else changes. That represents a reasonable return on investment for a high-quality business, particularly if inflation and interest rates are modest. However, we are not currently in an ideal environment. The reality is that the short-term global economic environment is filled with a lot of uncertainty because of many issues, including intensifying concerns about automatic spending cuts and tax increases (the so-called “fiscal cliff”) that will take effect unless a political compromise is reached, slower growth in China and the European sovereign debt crisis. But despite the short-term challenges, the long-term outlook looks bright because there are many strong franchises in the space that make for great long-term investments.