Why Value Will Outperform Growth

by: Cassiopeia Value Investing

A comparison between growth and value investing shows underperformance of value stocks since 2009.

Higher interest rates and inflation could turn the tide.

Market history is a good indicator for future performances and helps to develop the right investment strategy.

Investment Thesis

The world of stocks was always divided into growth and value stocks. Value investors and growth investors showed different performance results for different investing periods. In recent years, growth investing was much more successful than value investing. However, an analysis of data about past decades shows that value investing is likely to beat growth in the next decade.

More than ten years after the Financial Crisis of 2007/2008, many countries and stock markets have not fully recovered from its negative impacts.

Leitzinsen Chart


The chart above shows the interest rates for the USA (yellow), Japan (red), the EU (blue), and Great Britain (green). While interest rates increased for three years in the USA as a result of a growing economy, interest rates in other regions remained very low or zero. Low interest rates support a debt-producing environment for many companies.


From 2008 to 2018, corporate debt increased over 40% while the GDP of the USA just increased by 18.67% at the same time. In 2003, the starting situation was similar, as the interest rates stood at 1% and rose step-by-step. However, corporate debt also increased by over 37% from 2003 to 2008. The same happened during the last years because interest rates slightly increased to 2.5% in the USA now, but corporate debt has not stopped rising. Growth companies need low interest rates to finance current and new debt to grow more and more. As long as interest rates remain low, high debt burdens won't be a major problem for most companies but a tightening of Fed's monetary policy could be a major threat for growth-oriented companies and for the stock market in general, especially because current valuations implicate high growth expectations of investors.

Historical performance: an indicator for the next decade?

The current situation is an opportunity for value investors. A comparison between the Vanguard Growth ETF and the Vanguard Value ETF shows the outperformance of growth over value:

Chart Data by YCharts

The performance difference (without distributions) between the Growth ETF and Value ETF is a whopping 102.3%. On an annual basis, the Vanguard Growth ETF had a return of 14.7% p.a. while the Vanguard Value ETF returned 11.3% p.a. which are both satisfying returns over a ten-year period. However, growth investors could achieve an annual outperformance of 3.4%. The last period when growth investing was much more successful than value investing was 1993-1999.

Graph showing annual total return of growth and value stocks from 1993 to 2017


Interest rates in the US fell from over 10% to 3% in 1993. Hence, the Fed created a friendly environment for growth companies which caused the outperformance over value stocks. The dotcom-bubble crashed in 2000 as a consequence of bankruptcies and lower-than expected growth rates. The growth mania was over and value stocks gained popularity again. From 2000 to 2006, value investing outperformed growth every year. Since 2007, growth beat value every year apart from 2012 to 2016. The low to zero interest rates created a better environment than 1993 and were one of the reasons for the quick economic recovery after the Financial Crisis. To develop an investment strategy for the next decade, let's first define growth and value.

Growth stocks vs. value stocks


Growth stocks, in general, have higher multiples because their earnings growth record is better. Investors are willing to pay higher prices because they expect even higher stock prices as a result of high growth. Growth companies need much money to finance their expansion and have a long record of debt increases and/or increase in share capital (dilution). Growth stocks also rarely pay dividends. Typical current growth sectors are Technology, Biotech, and Healthcare.

The portfolio of the Vanguard Growth ETF (VUG) is dominated by these sectors (as of 05/02/2019):

Technology Consumer Cyclical Healthcare Industrials Financials Others
36.55% 17.87% 10.80% 10.14% 8.38% 16.26%

The biggest positions are Facebook (FB), Microsoft (MSFT), Apple (AAPL), and Amazon (AMZN).

The average P/E ratio for these four stocks is 33.7 and the average dividend yield is 0.725%. These companies did achieve earnings growth since 2012 (Microsoft's earnings are nearly flat) but they also increased their debt heavily. For example, Amazon's liabilities grew from $24.3 bn in 2012 to $119 bn in 2018 (+389%) and also Microsoft's liabilities more than tripled ($176 bn vs. $55 bn in 2012). As long as interest rates remain low, both companies can refinance their business, but if interest rates rise to levels of the 1980s, highly indebted companies have to deleverage or will face insolvency.


Value stocks can often be found in cyclical industries and have lower multiples than growth stocks. Many value companies have low earnings growth rates and pay stable dividends. Value stocks tend to lag in sustained bull market.

After ten years of rising stocks, the bull market is very old and growth stocks performed even better for the last three years (+61.2% growth vs. +43.7% value)

Sectors with value stocks are financials, consumer defensive, and energy and utilities.

The portfolio of the Vanguard Value ETF (VTV) is dominated by these sectors (as of 05/02/2019):

Financials Healthcare Consumer Defensive Energy & Utilities
22.2% 17.9% 10.9% 14.8%

The biggest positions are Berkshire Hathaway Inc. B (BRK.B), Johnson & Johnson (JNJ), Exxon Mobil (XOM), and JPMorgan Chase (JPM).

The average P/E ratio for these four stocks is 17.7 and the average dividend yield is 2.5%. The valuation is much lower as it can be expected for the Vanguard Value ETF than for the Vanguard Growth ETF. Surprisingly, all these companies apart from Exxon Mobil also achieved EPS growth since 2012. For example, J&J grew its earnings from $3.94 per share in 2012 to $5.7 in 2018 while debt increased "just" 65% ($93.2 bn vs. $56.5 bn). EPS growth does not necessarily need aggressive debt growth. JPMorgan Chase nearly doubled earnings ($9.04 per share vs. $5.22 in 2012) due to increased interest rates and without much new debt (liabilities 2018: $2366 bn (vs. 2012: +8.9%). Value companies do not need growth or expansion to improve earnings but they are better prepared for inflation, higher interest rates, or a recession because their balance sheet is stronger as a result of a lower debt growth during the last decade.


No one can predict future returns of the stock market. Historical developments are a good indicator of future stock returns. The two approaches growth vs. value investing were always competitors. For many years, growth outperformed value and vice versa. Because the last decade was the "decade of growth", it is likely that value will outperform growth again during the next decade. Firstly, value companies are currently cheaper than growth companies as their P/E ratios are significantly lower and their dividend yields are much higher. Secondly, economic growth and inflation are expected to gain pace in the next decade. As a result, interest rates will continue to rise which will be a major threat to highly indebted companies which include many growth companies. If inflation recovers to pre-crisis levels, it will be hard for growth companies to achieve high growth rates because costs (commodities, wages) will rise while at the same time interest expenses will also rise. Higher interest rates will be a boost for financial companies which include many value companies. Finally, the current valuations with a CAPE Shiller ratio of over 30 indicate significant downside potential because the average P/E ratio of US stocks is 15-16. While many value stocks trade for the average P/E or even lower, growth stocks have a downside risk of 50% or more.

All in all, value investing is probably the most promising investment strategy for the next years as the downside risk is limited and the past outperformance of growth will likely result in future outperformance of value.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.