One asset manager has likened growth investing to gambling: It can deliver the same dopamine rush as winning a hand at the blackjack table but not consistent, steady wins. While investing in growth is broadly considered more “fun” than investing in value, new research from GMO argues that the long-term alpha is in the value stocks.
According to the nearly 50-year-old asset management firm, 60 percent of value stocks outperform the market over five-year horizons.
“Everybody loves the idea of investing in the next Amazon or Nvidia,” GMO’s asset allocation team writes. “But we would argue that a strong reason to consider value investing is that, while it is potentially less exciting, your expected return is higher.”
Growth stocks, meanwhile, offer a different return distribution, with perhaps the most noticeable difference being that over twice as many growth stocks go on to become “10-baggers” (i.e., stocks that increase tenfold in value). But the often-ignored downside to chasing these success stories are all the inconvenient stocks that vanish from growth portfolios — never to be mentioned again.
Per GMO, the proportion of growth stocks that go bankrupt is over 50 percent higher than that of value stocks. Meanwhile, fewer than 40 percent of growth stocks have outperformed the market over five-year time frames.
Since the price paid for any asset is a crucial point when considering the potential returns, GMO writes that “all investors should be valuation-aware investors, not just dyed-in-the-wool growth or value investors. Although value stocks have, on average, delivered better returns than growth stocks, starting valuations could potentially skew the balance toward growth stocks from time to time.”
While spreads between value and growth stocks have been narrow for a little over a decade — suggesting a poor environment for U.S. value — they’re now extremely wide
With the buzz around AI’s transformative potential, investors are now pumping money into growth stocks. But GMO argues that while these investors are willing to throw money at growth stocks to chase a potential lottery-like payoff, now’s a particularly compelling time to favor value stocks.
Value stocks are trading at a roughly 35 percent discount to their typical relative valuation (value needs to beat growth by almost 55 percent just to return to historically normal relative valuations). “Even if this abnormally wide valuation spread does not narrow immediately, we believe value can still outperform due to what we call the rebalancing effect,” GMO writes.
Value benefits as some growth companies disappoint and become cheaper, entering the value index. Value also benefits as some value companies surprise on the upside and get repriced into the growth index. This effect is particularly pronounced when valuation spreads are wide since the valuation change associated with a move from value to growth or growth to value is large.
Hypergrowth is in the Private Space
Another manager recently told Institutional Investor that the hypergrowth that growth investors are seeking is happening in the private space. In the 1980s and 1990s, high-growing companies like Microsoft, Amazon, and NVIDIA went public with relatively low market caps (i.e., between $500 million and $1 billion). Now, private companies like OpenAI and SpaceX with valuations either approaching or exceeding $1 trillion.
“If you want to buy into that massive growth, you need to get it in the private space,” TIFF Investment Management’s CEO Kane Brenan told II in February.
