Investors in growth stocks think they’re pretty good at predicting the future, value investors don’t. To be sure, companies that are growing quickly are worth more (by valuation measures such as price/earnings) than one’s that aren’t. How much extra a growth stock investor is willing to pay depends on how quickly he expects the company to grow, and for how long. For example, investors in Tesla Motors expect strong growth for a long time. The total value of all of Tesla’s stock is about $30 Billion, Ford’s total value is about $60 Billion. Yet Ford’s annual sales is $145 Billion as compared to Tesla’s $5 Billion in sales. Ford is also very profitable whereas Tesla is losing money. The reason Tesla’s investors have valued it at half the size of Ford when the company only has 1/30th the sales is because they expect that to change. Presumably they base this expectation on the fact that Tesla has produced great cars in spite of the sizable challenges of starting a car company from scratch.
Growth investors look a stock like Tesla and conclude that it will do well for many years into the future because it has done well in the recent past. Value investors are more modest and look at a stock for what it is today, and assume the future will be similar. In Tesla’s case, a typical value investor would only become interested after the company has become profitable and the stock is trading at a reasonable price/earnings (P/E) ratio.
History is on the side of value. The book “Stocks for the Long Run” (Siegel 2014, p184) took a look at 55 years of high P/E (growth) stocks vs. low P/E (value) stocks. The author concludes that value stocks, on average, returned several percentage points more than growth stocks in the average year. This isn’t true for every year or even every decade. But long term investors are well advised to be humble, ignore the temptation to side with those claiming clairvoyance, and focus on value stocks.
The Haas Capital Management Value Strategy has done even better than what Siegel found. It beat the S&P 500 by about 8% annually before fees over its first 3 years (details here). Although this outperformance is unusually high (it’s one of the best performing strategies in the last 1 and 3 year periods as of 7/1/15) it is another data point that shows that value is better than growth.