By Rosilyn H. Overton, CFP, CRPS
There are thousands of stocks, but when you buy, you basically choose from only two categories — growth or value. The 1990s were years when growth reigned supreme. The past two years have belonged to value. Many professional investors favor one investment style over the other, but to have good returns on your investment without undue volatility, your portfolio should include both types. One of the reasons that mutual fund prospectuses always say “past performance is no guarantee of future performance” is that the style that worked the past few years is in fact unlikely to work the next few years.
Growth stocks are like red sports cars. Their internal growth rates let them speed ahead of the general economy. Their price is generally a higher multiple of their earnings than most stocks, and they often do not pay dividends. They are usually younger companies that are experiencing the benefits of a growing market. Sometimes, they are innovators that are gaining market share in a static market. The technology and entertainment stocks that led the recent bull market are quintessential growth stocks.
Like the sports car weaving through traffic, however, growth stocks are volatile. They speed up, then slam on the brakes. When the economy starts to falter, they can even crack up, with prices plunging rapidly. Certainly, the performance of growth stocks over the past two years brings home that point. The NASDAQ, home of technology growth stocks, is currently priced at 1,660, less than 35 percent of the high of more than 5,000 it reached in early 2000. Most of the outstanding returns that were accomplished in the prior five years have evaporated.
Value stocks are like a fine Swedish sedan — the design is boring and compared to the sports car, they plod along, but they will just keep going when things get tough and you can get 300,000 miles without a major overhaul. Typically, you will see food, consumer staples and boring things like valves and springs in the value category. Value investing looks for out of favor companies and industries and buys with the expectation that the intrinsic value will eventually be recognized.
During the growth glory years, value stocks made some advances, but compared to the effervescent growth stocks, their returns looked puny. It was virtually impossible to get people interested in a value fund that averaged 7 percent return when growth funds were going up at 25-50 percent per year.
Most people love the glamour of the growth stocks, but those who bought the NASDAQ will have to make close to 12 percent a year for the next four years to get back to their highs. Value funds tend to hold their prices better, even when value is out of favor. Value investors will tell you that volatility eats your return. But, times when growth stocks race ahead are usually times that value stocks languish. The prudent thing to do, since no one really knows which style will be the right one at a given time, is to divide your portfolio between the two types, weighting toward the one that fits your personal risk profile better.
The naïve investor always thinks that recent history is the way things will be forever. When money market rates were 18 percent, you could not get investors to buy long term bonds at 10 percent — interest rates were going to be double digit forever. When the internet stocks were flying, boring discount stores didn’t look interesting. Now the discount stores have been soaring, and microchip makers are languishing. Unless you are prepared to make unemotional and time-consuming analyses of where the next great thing is coming from, play it safe with a balance of growth and value, equities and fixed income. You can then concentrate on the things in life that interest you, and relax knowing that your portfolio can weather whatever storms that come.
Rosilyn H. Overton is the owner of the Mid-Atlantic Securities, Inc. office in Little Neck, NY. She has more than 30 years experience in the financial services professions, and was formerly the Chairman of the Financial Planning Association of New York. She is a Certified Financial Planner and a Chartered Retirement Plan Specialist. She can be reached at 631-4000.
