When I first started working at Morningstar over 23 years ago, what surprised investors most was the famous style box, which identifies the investment style of a fund based on value or whether it invests in a growth company or large or small cap. The size of the company was fairly easy to understand, but it was much more difficult to understand the “value” and “growth” components.
At the time, there were several independent fund managers who practiced value investment, but the general public knew little about the difference between the two investment styles.
Today, no one is scared to talk about growth or values anymore. However, just because regular investors, or at least those interested in financial markets and mutual funds in particular, are used to these terms, does not mean there is no misunderstanding about them.
Below we have compiled some of the most impressive misconceptions about value and growth investments.
1) Growth is in America, value is in Europe
The first thing investors have about value and growth is that they believe that the US market is a growth market and the European market is a value market. You cannot go far from the truth. In fact, if we break down the growth and value ratio of the index like this: Morning Star US Market Index and Morning Star Europe Indexwe recognize that Europe is growing more than the US. The three growth styles (large, medium, and small) are combined to reach a 34% percentage for the European index and a 22% for the US index.
This false belief is characterized by the fact that the US market is dominated by the so-called grand 7 (Apple) ApplMicrosoft MSTFnvidia NVDA,Amazon amzn,Meta Metaalphabet googland Tesla TSLA), stocks that the public in the public is associated with growing companies. What’s strange is that of these seven, only two Morningstar today classifies as growing companies Nvidia and Tesla.
On the other hand, when it comes to Europe, it is certain that its stock market is heading towards a “old economy” where valuable companies have more weight. However, looking at the large European companies with 10 market capitalizations, only one person is classified as value. shelland the five biggest ones are all growth companies.
2) The value is cheap and growth is expensive
In the definition of what a value company or growth company is (see details at the end of the article MorningStar learns how to classify companies as value or growth), there is the idea that a typical value company is cheaper than a growth company. In fact, value companies trade at a lower base ratio (price/revenue, price/selling, price/cash flow, etc.) than growing companies. But whether a company is “expensive” or “cheap” goes beyond these basic metrics.
Our equity analysts determine whether a company is overvalued or undervalued by estimating the fair value of the company. Its fair value could exceed or fall below the stock price. That’s what we decide, not whether the stock is expensive or cheap, or whether it’s a value company or a growth company.
Therefore, there are growth stocks in cheap and expensive companies. For example, in Europe, growth companies like ASML Holding ASML We consider the price to be cheap on February 12th as it has a reasonable price/value of 0.85. In contrast, US bank JPMorgan JPMclassified as value and trades at a price/fair value of 1.41 (indicates that it is overvalued at 40% or more).
That said, it is true that value has been cheaper than growth in recent years, but looking at the US market today, even the big value style is overvalued at just under 1%.
3) Investment can only be value or growth
The prevalence of the concept of value and growth in the financial community has led small investors to think from a binary perspective. The fund is value, or the fund is growth. But reality is much more complicated than that. For example, if we adopt a set of US equity funds available in Europe, we have 1,074 classes of growth funds, 680 class value funds, and 2,554 classes of funds called “blends.” In other words, there are more blend funds than value and growth funds.
The same applies to individual companies. Returning to the first chart showing a breakdown of European stocks and American stock index styles, we see that the total weight of the “blend” segment reaches 37% in the European case and 52% in the US.
4) The fund must remain the value or growth of life
This last concept of value and growth is perhaps the most difficult to rebuttal. I don’t deny the fact that funds tend to remain true to their investment style. It is rare for managers investing in the growth segment to suddenly turn their portfolios into value areas. Coincidentally, this type of shift would have been very profitable during the 2022 market slump. In fact, large-scale growth-style equity funds in the US fell by an average of 32% (in dollar terms) compared to an 8% decline in growth.
However, fund portfolios are dynamic and can change over time. I’m not saying that a fund can suddenly go from value to growth, but within the range of value and growth there is a different degree of exposure that explains partially achieved returns.
10 ratios to determine whether a fund or company is growth or value
To determine whether a fund or company is value or growing, we measure whether Morningstar is ranked as a company based on a 10 base ratio, the value characteristics of each security (estimated revenue, book value from price, sales price, cash flow, and dividend yield) and the growth characteristics of each company (future revenue growth rate, sales growth, book value growth, sales growth, sales growth, sales growth)5.
The most immediate way to know if your fund is a growth or value fund is to use one of the tools called Style Boxes. It is the board that appears in the fund’s files and is subdivided into nine boxes each representing the management style. Looking at the board vertically, all the funds placed in the three boxes on the right are prioritized investments in growth stocks. The one placed in the box on the left is the funds that primarily invest the portfolio in value stocks, and the one placed in the box in the center is a blend.
