Large Cap Growth and Value: A Dirty Little Secret

Recently we wrote an article asking, “Is Growth the New Value in Smallcaps?” on the premise that stocks in the iShares S&P SmallCap 600 Growth fund (IJT) were actually trading at a lower P/E ratio than stocks in the iShares S&P SmallCap 600 Value fund (IJS)—just the opposite of what you’d expect. That continues to be the case.

However, the story in Large Cap stocks is quite different. Despite nearly ubiquitous predictions from Wall Street’s prognosticators that growth stocks would finally start to outperform value stocks after being out of favor for more than half a decade, so far at least that hasn’t happened.
One reason could be what I refer to as a “dirty little secret:” namely, stocks in the iShares S&P 500 Growth fund (IVW) don’t actually grow earnings appreciably faster than stocks in the iShares S&P 500 Value fund (IVE)—they’re just more expensive!

Specifically, between 2002-07E, stocks in the Growth fund (IVW) have grown earnings at a compound annual growth rate of 14.6%, compared with virtually the same growth rate of 14.5% for stocks in the Value fund (IVE) (Figure 1). And in fact the value stocks fare substantially better than growth stocks if you extend the analysis to include the last recession.

However, unlike small cap growth and value stocks, the large cap growth stocks in IVW actually do trade at higher P/E multiple of 17.5x 2007E EPS, compared with 15.0x for stocks in IVE. So instead of getting faster earnings growth in exchange for the higher valuation multiples you pay on IVW, you just have to pay more. Once again this highlights a recurring theme in our ETF analysis, which is that you can’t judge a fund by its name.