Making Sense of the Current Growth vs. Value Dynamic

How Trends Compare to the 1990s and Why They Could Persist

By STEPHEN ATKINS & PETER HOLT/Guest Contributors

Many investors seem concerned that the current era of growth style dominance will come to the same untimely end as its 1990s predecessor. However, we think there are distinctions in the factors that have driven the current outperformance of growth vs. value, which could result in this cycle playing out differently than the prior one. Here’s why.

Key Highlights

• Current P/E levels relative to the 90s combined with a low interest rate environment, in our opinion, indicates that earnings growth has been a more significant driver of the recent outperformance of the Russell 1000 Growth Index (R1G) vs. Russell 1000 Value Index (R1V).
• Our research shows that the top contributors to the R1G’s performance saw far more economic value accrue to their businesses relative to their R1V counterparts, and we believe this demonstrates the underlying fundamental strength of the R1G companies.
• We believe the full promise of the internet boom is now being realized as the infrastructure required to support the momentous changes envisioned in the 90s are largely in place.
  

Since the market bottom of the Great Financial Crisis in March 2009, the Russell 1000 Growth Index (R1G) has outperformed the Russell 1000 Value Index (R1V) by over 300% cumulatively. This level of relative outperformance is reminiscent of the 1990s, along with the angst and frustration it seems to manifest for investors who allocate between the two styles. In fact, the cumulative outperformance of the R1G vs. the R1V during the eleven years from 2008-2019 has been roughly the same as it was in the period from 1988-1999.

Many seem fearful that this current era of growth style dominance will end with the same thud as its 1990s predecessor. According to the Wall Street Journal, growth stocks are on pace to outperform value stocks by the widest margin since the dot-com era, and many investors wonder how long this can last.[1] We make no claims about the future and acknowledge this paper could be poorly timed. Yet, despite the appearance of style déjà vu, we think the factors that have driven the current outperformance of growth vs. value are different than the previous incarnation.

Past vs. Present: Valuation vs. Earnings Growth

During the 1990s, the relative outperformance of growth vs. value was most pronounced towards the end of the decade when the excitement over the coming internet age reached a fever pitch. In just the two calendar years of 1998-1999, the R1G outperformed its value counterpart by a cumulative 60%. As shown in Figure 1, this outperformance was valuation driven—the relative P/E of the R1G, at its peak, reached 3.5x the P/E ratio of the R1V, a level far above the longer-term trend.

Analyzing 2008-2019, the relative P/E of both the R1G vs. R1V has certainly trended higher but remains well below the levels seen in late 1999/early 2000. It is also important to note that interest rates today are much lower compared to twenty years ago— if anything, this fact generally justifies higher growth equity valuations. Given this data, we infer that compared to the late 1990s, earnings growth has been a more significant driver of the recent outperformance of the R1G over the R1V.

Figure 1: Source: Factset; Fred Database. Click graph to enlarge.

The Economics of Today’s Growth vs. Value Dynamic

We can also examine the fundamentals behind the growth vs. value dynamic. Consider the accrued economic value (based on revenues) generated by the ten most significant contributors to each Index’s performance. This can help to properly frame the value created by the companies most responsible for the performance of each benchmark.
The charts in Figures 2-5 show the absolute change and growth in revenues and net income for the top ten largest contributors to each of the R1G and R1V over the past five and ten years.

Just looking at revenues, between 2009-2019, the ten largest contributors to the R1G’s performance generated $500bn or over 2.5X more in revenues than the ten largest contributors to the R1V’s performance. Between 2014-2019, the R1G’s top ten contributors generated $400bn more in revenues compared to the ten largest contributors to the R1V. If overall revenue and net income generation and the growth of these metrics are an indicator of underlying business strength, then the companies driving the R1G’s performance collectively appear to be much stronger than those driving the R1V’s performance. In this context, the comparative outperformance of the R1G seems hardly surprising. The top contributors to the R1G’s performance saw far more economic value accrue to their businesses relative to their R1V counterparts.

In our opinion, it would be irrational if the market did not assign a greater value, in the form of larger market caps, to these best-performing growth businesses.

Click to enlarge charts.

We were interested to see how the above data compared to the 1990s. While we do not have data on the largest contributors to each Index for this time period, we do know the largest Index weights which we feel can be used as a close proxy. We examined the five-year period ending 12-31-1999 and believe this is sufficient to make a fair comparison. As can be seen in Figures 6 and 7, while the largest-weighted companies in the R1G outgrew the largest- weighted companies in the R1V, it was to a much lesser degree compared to the 2014-2019 period. In fact, the largest holdings in the R1V generated a greater absolute increase in aggregated net income compared to the largest holdings in the R1G. We believe this further supports our view that the 1990s growth vs. value cycle was more valuation driven compared to today.

The main takeaway from this analysis is that the current growth vs. value cycle appears to us to be more fundamentally driven than the 1990s. The 1990s growth vs. value cycle may have begun as a fundamentally driven cycle. However, by the end of that decade, it had morphed into a valuation-driven mania that, even then, seemed unsustainable. 

If we conclude that today’s cycle is more fundamentally driven, the implication is that it may prove to be more sustainable than its 1990s predecessor. Only time will tell, but the companies who make up the most significant contributors to the R1G, led by the massive tech platforms, are seeing their business models driven forward by enormous structural trends around the digitization of the global economy, a shift that is perhaps still in the early innings.

The Full Promise of Digitization

Somewhat ironically, today’s digital transformation was significantly accelerated by the internet and mobility trends that had blossomed during the 1990s. In a sense, that era’s excitement about the momentous changes these technologies would create was more than justified—the stock market was simply too far ahead of many of the actual business models. These models required a level of infrastructure (computing power and storage, mobility networks, data speeds, etc.) which was, arguably, inadequate at the time. Today, with much of that needed infrastructure in place, the full promise of the internet boom is now being realized.

Many of these platforms are now the largest companies in the U.S. growth indices, and, in our view, they are some of the more powerful business models we have seen in the 30+ year history of our firm. When viewed through this lens, the outperformance of growth vs. value for the past ten years is not only unsurprising but may continue, as long as its fundamental underpinnings remain in place.

We recognize why today’s growth cycle might create some uneasiness, especially when it feels eerily similar to the eleven-year growth cycle of the past. Yet, the fundamentals tell us that today’s growth cycle is largely being supported by earnings growth, the stronger underlying economics of the businesses, and the full realization of digitization’s promise, which we believe has many more years ahead.

Sources

[1] Otani, A. (2020, May 19). Growth Stocks Outperforming Value by Widest Margin in Decades. Wall Street Journal. https://www.wsj.com/articles/growth-stocks-outperforming-value-by-widest-margin-in-decades-11589904864

Polen Capital is an Associate Member member of TEXPERS. The views expressed in this article are those of the authors and not necessarily Polen Capital nor TEXPERS.

About the Authors

Stephen Atkins, CFA, is a Portfolio Strategist and Analyst at Polen Capital. He joined Polen Capital in 2012. Prior to joining Polen Capital, Atkins spent 12 years as a portfolio manager at Northern Trust Investments, including eight years as a mutual fund co-manager. Before joining Northern Trust, he spent two years as a portfolio manager at Carl Domino Associates, LP. Atkins received his bachelor's degree in Business Administration from Georgetown University and a General Course degree from the London School of Economics. He is a CFA charterholder and a member of the CFA Institute and the CFA Society of South Florida.

Peter Holt is a Data Analyst at Polen Capital. He joined Polen Capital in 2018. Holt was born and raised in South Florida and graduated as salutatorian from Westminster Academy in Fort Lauderdale. Holt received his bachelor's degree in Economics from Princeton University with Highest Honors, and he was the recipient of the Burton G. Malkiel ’64 Senior Thesis Prize for the most outstanding senior thesis in the field of finance. Prior to joining Polen Capital as an employee, Holt interned with the company in the summer of 2017.