Andrew's Angle

Growth is not the opposite of value

Nov 7, 2018

The capacity of factor strategies appears large 

Investors often think of growth as the opposite of value. Not exactly. While some growth stocks are indeed expensive and over-priced, growth-oriented factors like momentum and quality are long-term drivers of return.

It’s partly my fault, speaking as a former professor. But when I emphasize that growth is not the opposite of value, it often elicits bewildered responses.

We didn’t always use growth to refer to the opposite of value—stocks with low prices relative to intrinsic value. Some of the early papers in the literature used “glamour” to denote expensive stocks as the opposite of value stocks1. But academics switched gears, and started to use the word “growth” to refer to the opposite of value—and thanks to them, many investors pit value against growth like two gunslingers in an old western movie.

In practice, we would have been better off using “anti-value” for expensive stocks and “value” for cheap ones. We certainly want to buy cheap, and value investing has been rewarded over the long run.

But sometimes, we might pay more for growth.

What components of ‘growth’ are in factors?

As Warren Buffett once wrote in a shareholder letter, “Growth is simply a component – usually a plus, sometimes a minus – in the value equation.”

What Buffett meant by this is that expectations of future growth affect a stock’s intrinsic value. Some aspects of growth are related to other rewarded factors and those factors have historically exhibited long-term returns.

Why might investors pay more for growth-oriented securities?

  1. Strong trend: investors seek winners which tend to keep winning
  2. Strong balance sheet: investors are willing to pay more for stable earnings

Let’s take the Russell 1000 Growth index and determine its exposures using a factor lens

Less than 40% of the Russell 1000 Growth Index constituents are considered momentum or quality! The remainder of the Russell 1000 Growth Index constituents can’t be linked to either of these two growth-oriented factors, which have yielded broad and persistent sources of return. Attributes of the remaining growth style category constituents can be linked to positive returns for some managers, but are associated with negative returns for others. Even for those growth managers able to generate positive returns with this remaining subset of holdings, those returns may be fleeting. While holdings classified as quality or momentum have demonstrated their ability to deliver long-run returns over decades.

Factor Constituents of iShares Russell 1000 Growth Index

Factor Constituents of iShares Russell 1000 Growth Index

Source: BlackRock as of October 2018.
Based on total number of constituents in iShares Russell 1000 Growth Index held in either iShares Edge MSCI USA Momentum Factor ETF or iShares Edge MSCI USA Quality Factor ETF.

Why pay more? To buy the trend

Momentum is pervasive. And many successful growth managers want to identify and participate in trends.

Research in the late 1980s and early 1990s demonstrated that price momentum was prevalent, not only in equities, but across asset classes. Research has shown that assets that have been trending for six to 12 months have tended to continue to trend in the same direction for some time before reverting. Over the long-run, investing in a basket of securities that have risen relative to the broader market has driven outperformance. Similar to the recent environment, momentum has historically logged its best returns during economic expansions.

Momentum Excess Return by Decade, 1900-20101

Momentum Excess Return by Decade, 1900-2010

Source: BlackRock as of October 2018.
1 Geczy, C. and M. Samonov (2013). “212 Years of Price Momentum (The World’s Longest Backtest: 1801 – 2012).”
During the 1910-2010 period, two data sets were used in the research, Global Financial Data from 1825-1926 and the Center for Research in Security Prices (CRSP) is relied on for its database of security prices from 1927-2010.
Winners (W), losers (L) and momentum (W-L) are defined by each stock’s price change each month of the research sample. Stocks with the highest momentum are assigned to the winner (W) portfolio, and stocks with the lowest momentum are assigned to the loser (L) portfolio. Excess returns of momentum (W-L) are calculated by subtracting average return of all stocks in the sample from the momentum portfolio return. Portfolios are rebalanced monthly. Excess returns by decade are annualized ten-year return, ending at period end date.

Why pay more? For higher quality

Quality investing is about holding companies with the potential to grow sustainably over a long time. Companies with high quality, stable earnings have delivered outsized performance relative to short-term headline grabbing earnings.

Quality earnings were first identified by Benjamin Graham and David Dodd in 1934, in their book, Security Analysis, but it took until the 1990s when we started to treat quality as a separate factor.

Quality is an aspect of growth that is inherently defensive. Due to their financially sound characteristics, high quality companies are generally able to better weather an economic cycle. Quality companies have historically demonstrated their greatest outperformance during slowdown and contraction phases. Conversely, when the market rallies, quality can lag the broader market.

So, should you consider investing in ‘growth’?

Growth = expensive?
No! We prefer securities trading at discounts relative to their fundamental values.
Growth = positive momentum?
Growth = quality earnings?
Momentum and quality are long-run rewarded factors.

Good Growth, Bad Growth

As a former academic, I told you it was partly my fault. Growth can be an illogical category. We have to look closer within the group to identify the true nature of these investments.

Thinking of growth just as the opposite of value is too limiting. Value investing has certainly been rewarded over the long run. Bad growth is the opposite of value, and we prefer securities with embedded value characteristics.

But there is good growth, too. Growth-oriented factors are momentum and quality. These attributes of growth help demystify the growth universe and uncover investments that benefit from these long-term drivers of return.

Andrew Ang
Head of Factor Investing Strategies
Andrew Ang, PhD, Managing Director, coordinates BlackRock’s efforts in factor investing. He leads BlackRock’s Factor-Based Strategies Group which manages macro ...