Does it matter whether you are a “value” or “growth” stock? (2024)

Everybody would like to manage a growth company. One metric that has been used for decades is the classification as a "growth stock" in the S&P 500 Growth index. And that sounds reasonable. S&P writes [1]

In the latest edition of our valuation textbook [2], we show an analysis that looks at the underlying sales growth and Return on Capital (ROIC) for companies in the S&P 500 "Growth" and "Value" indexes (excluding banks and insurance companies). You can also find the original article from 2007 here. Since it was a little old, my colleagues Rosen Kotsev, CFA , Marc Goedhart , Jose Afonso Silva and Víctor Rojas Sánchez updated the analysis a few weeks ago.

Turns out, the old analysis used S&P500 Value and Growth indexes that had 140 companies overlapping in both data sets. This is interesting in itself - how can a company be both in the "growth" and the "value" index? An indication that this is not as clean as the "common sense" would like you to believe. As an example, currently,

In the new analysis, we used S&P "pure" indexes with no overlap, which were introduced in 2005 (exhibit). These "pure" style indices have only about 80 constituents each, which leaves 340 out of the SP 500 companies that are not classified as either growth or value. You can clearly see that the lines are still overlapping quite a bit (X axis in the sales growth and ROIC, respectively; Y axis is the percent of companies) [3].

So the "pure" style does help to differentiate better than the older, larger, indexes: "Growth" companies clearly have a higher median growth (~25% vs. ~11% for value). On the other hand, even with the stricter index definition

• "Growth" companies also have a higher Return On Capital than "value" companies (median of 32% vs. 15%)
• 24% of "value" stocks have growth rates higher than the median of "growth" stocks.

See Also

Investing for growth, income or bothThe truth about growth and value stocksMore on Growth vs. Value Investing - Oakmark FundsValue or Growth Stocks: Which Is Better?

As practitioners, we are used to estimating value to get insights. So let's do exactly that: A two stage value formula that uses a 9% WACC, a 5 year growth period and a continuing value with the same ROIC at 3% growth results in these estimates for unlevered P/E [4], [5]:

Let's bridge the 15x estimated multiple of the median "value" company to the 27x multiple for the median "growth" company. Of the 12x difference,

• 4-7x multiple increase comes from ROIC
• 5-8x multiple increase comes from growth

Again and again, we find that these concepts of growth versus value alone are just not meaningful. Companies can have high multiples because they have high growth and moderate ROICs, low growth and high ROICs, or high growth and high ROICs. Branded consumer products companies, for example, have high ROICs but modest growth, while hot retail companies have high growth and modest ROICs.

How do you think about this? Is it important to you or your clients/company how you are classified? Do you think investors really care?

[2] Koller et al., Valuation: Measuring and Managing the Value of Companies (Wiley Finance); 7th Edition

[3] S&P 500 Pure Value Index (SP500PV) and S&P 500 Pure Growth Index (SPXPGKN) definitions as of 27th November 2023. Excludes banks and insurance companies. 50 unique value companies, 68 unique growth companies; uses financial data until 2022

[4] For the two stage value driver formula, basically a simplified DCF with ROIC and growth as drivers, please see the valuation book

[5] A 10 year timeframe for 25% growth seems aggressive. at 32% ROIC, it would lead to a 55x P/E, which is not unheard of but doesn't feel like fair representation of a median growth company