Here is the essential life cycle for stocks that drives returns
The battle between growth and value has been raging since the dawn of investing. Growth investors are willing to pay higher valuations for above average growth while value investors look for low multiples like Price/Book and Price/Earnings. Each category has many subsets. In the growth camp are Momentum and GARP (Growth at the Right Price) while value caters to investors like Warren Buffet more focused on buying a dollar's worth of assets for 50 cents. In the end both can prove profitable but like most things in life, timing is everything.
The most recent battle can be seen comparing iShares S&P 500 Growth ETF (IVW) vs iShares S&P 500 Value ETF (IVE). As you can see in the 1 month chart above value investors are attempting to retake a lead they’ve relinquished for most of the last 5 years.
Clearly during that time investors have been willing to pay ever increasing multiples for companies that could consistently grow revenue and earnings. Healthcare has been the prime beneficiary with the biotech index now up 386% in that time frame.
In March of last year value stocks made an attempt to retake the crown lost since the dawn of the financial crisis. At the time, I sat down with Yahoo Finance Anchor Aaron Task to discuss growth’s waning momentum. My thesis was short lived as growth soon pushed ahead taking the baton from value and until recently never looked back.
What’s holding back growth?
Estimate Revisions - It’s no secret that estimates have been coming down most of the year and recent data has proved problematic for momentum players. The table from Thomson/Reuters speaks to a problem that seems to be getting worse. In the last week alone there were 86% more downward revisions than those revised higher. At present it looks like Q1 and Q2 could show negative year over year growth and most year-end projections are back-end loaded. If growth stocks are going to regain their mojo, this dynamic has to change.
There’s more to growth stocks than just price momentum. Growth investors look to companies with a steady stream of estimate revisions to the upside as well as the ability to beat those raised expectations. The current environment is not what the Doctor ordered. While there will be plenty of earnings beats in the quarter reporting, 2015 should probably have an asterisk.
* Estimates have been cut dramatically since the start of the year so the bar may be low enough for many companies to step over.
The Dark Side of M&A
Many seem to think M&A could drive the next leg of the bull market. When two vibrant companies growing organically join forces the sky’s the limit. However, recent M&A proposals like Royal Dutch’s (RD) take-out of BG show the real driver behind their purchase may be the $2.5 Billion in annual synergies. The cost savings could drive earnings growth in a sector that is clearly challenged. I expect more deals between companies looking to cut their way to profitability.
Timing is Everything
I said earlier that timing is everything and as in life so it is for investors. I can’t remember where I first came across the Stock Clock but it shows the importance of reasonable timing.
Value Investor - We would all like to be deep value investors, picking up stocks at a cycle low but it’s probably the toughest of all strategies. The company is generally dealing with severe issues that have torpedoed earnings and their stock price. As you can see in the graphic the good value investor usually sells early to the...
GARP (Growth at the Right Price) Investor - Searching for companies that already are past their inflection point they look for companies that are growing top and bottom line but still with reasonable valuations. If the investment works out this investor usually sells out to the...
Momentum Investor - MOMO investors, as they are often referred to, are comfortable buying late in the cycle as long as the trend and price momentum remain intact. Good momentum investors ultimately sell to the...
Bad Momentum Investor - This unfortunate group has identified the security to late and is likely in at the top or very close to it. Eventually after succumbing to heavy losses they capitulate selling to the...
Bad Value Investor - Bad value investors are looking for all the same attributes as the good value investor but unfortunately has entered the security too early. Unwilling to suffer more pain they often sell to the good value investor and the cycle starts all over.
The important take away is that there are many styles of investing that can succeed but in the end, timing is everything.
Look Ahead
Over the weekend People’s Bank of China announced a full 1 percentage point cut in the reserve requirement the largest they’ve made since 2008. Given recent data coming out of the country it’s clear they’re concerned about growth.
After Friday’s rout we’ll see if Central Bank actions are enough to steady world markets.