Through Friday April 22nd, large cap growth stocks returned -17% year-to-date, as represented by the Russell 1000 Growth Index. Top holdings in the index are Apple (13%), Microsoft (11%), Amazon (7%), Google (6%), and Tesla (4%).
Large cap value stocks, as represented by the Russell 1000 Value Index, lost less with a return of -3%. Top holdings of the index are Berkshire Hathaway (3%), Johnson and Johnson (2%), United Health (2%), JP Morgan (2%), and Procter and Gamble (2%).
The most expensive growth stocks became to value was the late 1990’s dotcom bubble. Around the turn of the millennium the P/E ratio of value-to-growth stocks was 0.3. Once the bubble burst, growth was still priced higher than value, but in line with its historically average ratio of 0.7. At the conclusion of the financial crisis, for the only time in modern history, growth stocks were priced the same as value stocks. Investors favored safety and return of capital over growth and return on capital.
Source: Morgan Markets, March 2022, JP Morgan
From parity at the depths of the financial crisis, when the S&P 500 bottomed at 666 in March of 2009, growth outperformed value. The outperformance really started to accelerate in 2015. Growth stocks began the period 10% more expensively priced than value stocks, but eventually rose to 40% more expensive. Consequently, growth stocks outperformed value by 4% a year. In other words, much of the outperformance arose from the relative valuation expansion of growth stocks.
Source: Mulholland and Kuperstock Asset Management. IWF = iShares Russell 1000 Growth Index ETF. IWD = iShares Russell 1000 Value Index ETF.
After underperforming value stocks by 14% year-to-date, how do relative valuations for growth and value compare today?
Value stocks are priced at 16.3 times earnings, growth at 23.4, for a ratio of 0.70, exactly in line with the 25-year average. Value stocks are priced 16% over their historical average. Growth stocks are priced 13% over their own average.
While neither cohort cheap is on its own, it does introduce a simple heuristic that may help investors in the process of stock selection. Consider that Apple is priced at 26 x forward earnings while Google 21. The former appears expensive to its growth cohort, while the latter is priced in line with the growth average. In the value cohort, a company like Cigna (CI) is priced at 11x earnings, well below what has historically been deemed reasonable for a value stock.