Academics have for many decades promoted the idea of stocks being either value or growth stocks given certain parameters. The whole idea is completely disengaged from the real world and today the two investment styles are highly correlated as the return in value stocks currently explains 91 percent of the variation of the return in growth stocks.

This idea of value and growth stocks has infected the investment industry so much so that in response it has churned out tonnes of stock indices, mutual funds and ETFs based on this idea. Before we embark on our analysis of value or growth and why it is useless for the investor, we believe a quote from Warren Buffett on the subject perfectly sets the scene.

* Common yardsticks such as dividend yield, the ratio of price to earnings or to book value, and even growth rates have nothing to do with valuation except to the extent they provide clues to the amount and timing of cash flows into and from the business. Indeed growth can destroy value if it requires cash inputs in the early years of a project or enterprise that exceed the discounted value of the cash that those assets will generate in later years. Market commentators and investment managers who glibly refer to growth and value styles as contrasting approaches to investment are displaying their ignorance, not their sophistication. Growth is simply a component – usually a plus, sometimes a minus – in the value equation.
*(Warren Buffett, Berkshire Hathaway Annual Report 2000)

**The Oracle from Omaha puts it well but before we elaborate let us take a look at some quantitative measures of the relationship between the Russell Value 2000 Index and the Russell Growth 2000 Index. The scatter plot below shows the relationship between U.S. value and growth stocks (as it is defined by Russell Investments) on monthly returns since January 1995. The R squared basically tells us that the monthly returns on value stocks explain 67 percent of the variation in growth stocks’ returns in the period since January 1995; the square root of R squared says that the correlation between value and growth stocks has been roughly 82 percent. This is a rather high number in the world of diversification. In other words it does not matter statistically whether you choose the Russell Value 2000 Index or its equivalent growth index as your equity component in a diversified portfolio with say corporate bonds and U.S. treasuries.**

Source: Bloomberg, Saxo Bank Strategy & Research

One of the biggest fallacies and assumptions in many models is the idea of constant correlations which was a pivotal assumption in the credit risk model used to assess risk and price on CDOs before the financial crisis of 2008. Looking at the chart below of rolling 36 months correlation on value and growth returns since 1998 it is clear that correlation is not a static parameter but highly dynamic. More troublesome for the whole idea that value and growth are two different animals is the fact that since the beginning of 2009 the correlation coefficient has been very steady between 0.91 and 0.95 which is a very high correlation between two different investment styles. In fact, if you calculate the R squared on the current 36 months correlation you can see that the return in value stocks explains 91 percent of the return in growth stocks. Basically a statistical test will tell you that we may not be able to reject the possibility that the correlation between value and growth is 1.

Source: Bloomberg, Saxo Bank Strategy & Research

Getting back to the concept of value vs. growth we are of the opinion that it is a waste of intellectual energy to think about or even base a strategy on. Even value investing, which is a very common phrase, is in essence a redundant concept because what is investing if it is not about seeking value (as in intrinsic value) worth at least the price you paid for the shares? A company growing at 20 percent annualised can easily be a “value investment” if the stock price is below the company’s intrinsic value per share. The growth element is just a component in the overall assessment of the intrinsic value – hence the concepts “value” and “growth” are tied together. It would therefore be more appropriate if investors spend their time on assessing intrinsic value instead of basing their investment strategies on buying growth or value.

Source: www.tradingfloor.com