Value investors cooling their heels as growth stocks stay hot

Value investing may be out of favor as a result of the massive run-up in growth stocks, but it’s not out of date, according to Christopher Davis, partner at Hudson Value Partners.

“In 2024, I think there are a lot of misconceptions about what value investing is,” said Davis. “People think it's stodgy, out of date or not investing in tech stocks. And that's absolutely incorrect. Value investors will invest in any asset at the right price.”

At the end of 2023, more than half of mutual funds and ETFs were reportedly passive. Throw in the direct indexing SMA's that often masquerade as active management and the number is likely even higher. Put it all together and that means a minority of investors are looking at the price of a security relative to the fundamental earnings power of the enterprise before they hit the buy button.

In Davis’ view, the growing scarcity of real security analysis offers value investors like him an advantage because much of his competition is buying and selling for reasons that have nothing to do with a given company. 

“Warren Buffett famously asked, ‘if you don't believe in value investing, what do you believe in?’ And right now, with so much of the market having shifted to passive, whether it's mutual funds and ETFs, it's now a minority of people who are active investors,” said Davis, who oversees over $500 million for clients.

Davis adds that it's strange with the rise of web shopping that most people will spend more effort "finding the best price on a TV than they will trying to find the most earnings for every investment dollar they have."

He attributes a lot of the enthusiasm of younger market participants for growth investing, as opposed to deep value, to the fact that they came of investing age after the 2008 Great Financial Crisis when capital was free and “growth at any price was the order of the day.”

“Central banks enriched asset owners at the expense of savers,” said Davis. “It's hard for them to realize that the index can go down, that the leaders of the market in one decade aren't always the leaders in the following decade.”

The good news for value investors is that value stocks have not gone down in the past year. The iShares S&P 500 Value ETF (Ticker: IVE) is up a respectable 15 percent.

On the other hand, the iShares S&P 500 growth ETF (Ticker: IVE) is up over 32 percent. That makes for a tough conversation with clients at times - even the older ones who have lived through market downturns.

“Where value investing can really shine is in the challenging decades - the broad market - the S&P was actually down over the period from June of 2000 to June of 2010. Similar time periods occurred in the late 60s and 1970s. Just owning the market didn't do you any good. You needed to be selective about what you owned,” said Davis.

Added Davis: “Modern value investors don't just buy the cheapest third of the market and hope for the best. That's almost as dangerous an approach as hoping momentum stocks keep going and that you find your chair before the music stops.”

And the music will eventually stop, says Daniel Lash, certified financial planner at VLP Financial Advisors, and fellow value investor.

“We went through a long period of time, from 2000 to 2010 approximately, where growth investing significantly underperformed value and at that time it was being written that is growth dead,” said Lash. “Asset classes will move in cycles when one will outperform others for a period of years."

As an example, Lash points to the fact that large cap has been outperforming small cap the past 5 to 10 years, while growth has simultaneously been thumping value.  The concentration of the growth names leading the outperformance is concerning in Lash’s view, as this bull run has been anything but diversified with the top 5 stocks in the S&P – Microsoft, Nvidia, Amazon, Meta and Apple – making up over a quarter of the index.

“When those growth leaders fail to continue to increase revenue growth at a rate acceptable to shareholders, we will likely see a decline in their stock price which could be significant due to their outsized returns over the past 5 years,” said Lash. 

“Value will come back into favor at some point due to lower P/E ratios and above average dividends but when value will outperform growth is a guess that nobody knows,” said Lash, adding, “nothing lasts forever.” 

Davis agrees that it’s tough to call the turn, adding his own cliché to sum up the long, yet hopeful wait for value investors, “It's always darkest before the dawn.”