Investment opportunity: Is the share market switching to value?

Growth investors have been well-rewarded over the past decade. For example, the S&P500 index (US market) has delivered an average return of 14.5% p.a. over the past 10 years solely off the back of growth stocks, mainly technology. However, this year to date, value has outperformed growth. If this continues, it could have significant implications for investors.Value versus growthA ‘value’ approach involves investing in companies that appear to be under-valued by the market. Investors use a number of ratios to measure whether a company is under or overvalued including price-earnings (PE) ratio, book to market value and so on. The investment thesis is that there is a large body of evidence that demonstrates your starting valuation is a good indicator of future returns. When valuations are low, subsequent returns are high. Such companies also tend to have strong fundamentals including strong cash flow, profitability, strong balances sheets, etc.A ‘growth’ methodology is less concerned about whether the company is fairly valued by the market. It is all about future potential for growth. Growth investors are encouraged to focus mainly on top line indicators such as user numbers, revenue and growth potential e.g. how big the market could be one day. It seems that profitability is rarely a consideration.Tech has been a big contributor to growthThe large US tech companies have been major contributors to the stock markets growth over the past ten years. The chart below measures how much the FAAMG stocks (being Facebook, Amazon, Apple, Microsoft and Google) have contributed towards the overall performance of the S&P 500 index over the past 1 to 5 years. Over the past 5 years, they are responsible for driving almost half (48.4%) of the index’s return.If we look at the PE ratios that these FAAMG stocks, we can clearly see that valuations seem unsustainable (Facebook = 31, Amazon = 81, Apple = 36, Microsoft = 38 and Google = 37). To put this in context, the average PE for the S&P 500 has historically ranged between 14 and 18.Growth has been the clear winner over the past decadeThe chart below (published by Dimensional) compares the returns from value and growth since 1926. As you can see, for 84 years (between 1926 and 2010), value was the clear winner. But since 2010, growth has out-performed, particularly over the past 3 years.But value has performed better this yearOne thing that is for certain in financial markets is that outperformance never persists forever. Markets move in cycles. Returns eventually revert to their long-term mean. That means that periods of relative out-performance usually are followed by periods of relative under-performance.The chart below produced by S&P Dow Jones below illustrates the returns for the 3 months ended 31 March 2021. ‘Pure value’ was the second highest performing factor returning 21%. That compares very favourably against ‘pure growth’ which returned only 0.8% for the period.In Australia, the performance differential was just as stark. ASX200 Value returned 8.5% for the 3 months ending March 2021 whereas Growth lost 0.09%.What has changed this year?It is natural to question why the market has switched fromgrowth to value this year. ThMy new book is available for pre-order now: Pre-ordering the book will help me get it into bookstores. So please do me a favour - please consider pre-ordering now - links and pre-order bonus are available here: https://prosolution.com.au/book-preorder-bonus Do you have a question for the podcast? Email us at [email protected]. If you're interested in working with our team and me, discover how we can work together here: https://prosolution.com.au/family-office-servicesIf this episode resonated with you, please leave a rating on your favourite podcast platform. Subscribe to my weekly blog: https://prosolution.com.au/stay-connected IMPORTANT: This podcast provides general information about finance, taxes, and credit. This means that the content does not consider your specific objectives, financial situation, or needs. It is crucial for you to assess whether the information is suitable for your circumstances before taking any actions based on it. If you find yourself uncertain about the relevance or your specific needs, it is advisable to seek advice from a licensed and trustworthy professional.