Avoid the herd mentality on growth vs. value stocks

CHICAGO Fri Feb 22, 2013 11:06am EST

Traders work on the floor of the New York Stock Exchange, February 15, 2013. REUTERS/Brendan McDermid

Traders work on the floor of the New York Stock Exchange, February 15, 2013.

Credit: Reuters/Brendan McDermid

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CHICAGO (Reuters) - In the mercurial world of stock market trends, predicting whether the market is favoring growth or value styles is an either/or situation.

Sometimes growth stocks, which tend to produce consistently higher earnings, dominate. Then they fall out of favor, as value stocks, bought at bargain prices relative to their potential market value, take the limelight.

The nature of the beast in the growth vs. value tug of war is that when big money managers conclude that growth stocks may be getting overpriced then it is time to look for bargains. Since institutions tend to move in a herd, a switch en masse happens almost simultaneously and billions flow into bargain-priced stocks over a period of months. Sometimes the buying lasts for years.

Indeed, the value shift appears to have gained some ground year-to-date through February 15, as the value ledger of the S&P 500 rose 7.3 percent compared to 5.4 percent for growth stocks, S&P reports.

"We do think that this is a trend that could have legs," says Todd Rosenbluth, director of Mutual Fund Research for S&P Capital IQ, a market research company based in New York. "But it's still early in 2013."

The last major value cycle ran roughly between 2001 and 2008. That was in the wake of the dot-com implosion and recession of 2001, when growth stocks largely crashed and burned after the manic tech-bubble run of 1998 to 2001. In the recovery from the 2008 meltdown, though, growth stocks have largely dominated, as companies rebuilt their earnings streams.

Although you can make money in either market phase, the value cycle might benefit you better because it tends to step away from stocks that can be overvalued and due for declines. Unlike growth stocks near the peak of their popularity, value stocks often offer more upside potential.

Sometimes popular growth stocks like Apple, are burdened with unrealistic upside expectations and any disappointment in news or earnings leads to a sell-off. Since hitting a 52-week high of $705 last September, for example, Apple stock has seen a precipitous decline and has been trading under $500 of late.

While short-term trends can be misleading, some recent evidence points to a value upsurge. Large-cap value funds, according to Lipper, a Thomson Reuters company, gained 17 percent for the one-year period through January 31. That compares with 16.8 percent for the S&P 500 Index and 13.3 percent for large-cap growth funds.

It could be that the recent value returns are driven by heavy weightings in the financial sector, underdogs in recent years that experienced a comeback last year and rose more than 24 percent as a group. Or, maybe the tide is turning and large institutions are making a shift toward value investing.

Although no one really knows when a cycle makes a turn in real time - it is best to make this call through the rear-view mirror - consistently investing in value offers a way to grab bargain-priced stocks with slightly lower volatility and higher dividends than their growth cousins.

HOW TO INVEST

In considering value stocks, it makes sense to diversify across countries and the size of companies: large-, mid- and small caps. Index funds generally give you the broadest array.

For large companies, the Vanguard S&P 500 Value ETF, invests in more than 350 stocks found in the S&P 500 Value Index. The companies in this portfolio may not seem like value stocks, but are mostly household names such as General Electric Co, Exxon Mobil Corp and AT&T Inc.

It is also a good way to own the company run by Warren Buffett, Berkshire Hathaway Inc, which is a living testament to value investing; the fund has a 2.6-percent stake in the company. The Vanguard fund was up nearly 20 percent for the year through January 30.

Vanguard also has a Mid-cap Value ETF that tracks the MSCI US Midcap Value Index and holds companies like Mattel Inc and Seagate Technology PLC. It was up 18 percent over the same period.

For small companies, you will not encounter any brand names, but you may see some greater potential for appreciation. The WisdomTree International SmallCap Dividend ETF focuses on companies across the world that also pay dividends, which is a rarity for companies under $1 billion in market capitalization. The fund returned almost 20 percent over the annual period through January 30. and pays a 3.4 percent yield.

By employing a balanced approach, you could split the difference between growth and value funds - 50 percent each - or simply buy a fund that tracks an index with a larger number of stocks in it. The iShares Russell 3000 Value Index holds 10 percent of its portfolio in small caps, although it is still dominated by mega-caps such as Procter & Gamble Co and Chevron Corp. The fund gained 20 percent for the year through January 30.

(The author is a Reuters columnist and the opinions expressed are his own. For more from John Wasik see link.reuters.com/syk97s)(Follow us @ReutersMoney or here; Editing by Beth Pinsker and Nick Zieminski)

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