Everybody’s Styling

April 21, 2005


Russell, like MSCI, uses a system that allows stocks to be classified as partially growth and partially value, with their market capitalization split between the two styles.

Russell's growth/value analysis is much simpler than MSCI's, however, relying on just two variables to determine "growth" vs. "value":

  • Price/book ratio
  • Long-term forward growth estimates.

The two components are considered equally, a middle-of-the-road approach that offers a compromise between the "book value indexers" and the "earnings indexers."


S&P/Barra stand firmly on the "book value" side of the book value/earnings debate. The venerable indexing team[4] uses the price/book ratio as the sole factor in their style breakdown.  And they make no bones about why they rely on such a simple system.

"Clearly, there is no definitive way to characterize a value versus a growth stock," the companies explain in their promotional literature.  "However, the book-to-price ratio has the advantage of being simple and easy to understand, is mutually exclusive, and captures one of the fundamental differences between companies generally classified as value companies or growth companies."

S&P/Barra also point out that price/book ratios tend to be stable over time, reducing portfolio turnover.

The S&P/Barra system assigns companies wholly to one index or the other; there's no splitting companies up and assigning part of a company's market capitalization to each index.

Morningstar: Mr. Style

One of the biggest names in style-based investing is Morningstar, the massive mutual fund and equity research company.  Best known for its "style box" analysis of mutual funds, Morningstar also offers a full suite of style indexes covering 97 percent of the U.S. equity market. 

Launched in 2002, the Morningstar style indexes rely primarily on earnings-related data to divide the market into growth and value.  Interestingly, the Morningstar indexes feature three categories: growth, core and value.  Stocks that do not exhibit either strong growth or strong value characteristics are placed in the "core" category, a nice feature that circumvents the complication of dividing up a stock's market capitalization between two indexes.  On average, each of the three categories represents one-third of the total index market capitalization.

To evaluate the growth characteristics of a stock, the Morningstar indexes rely on:

  • Long-term projected earnings growth (50 percent weight)
  • Historical earnings growth (12.5 percent weight)
  • Historical sales growth (12.5 percent weight)
  • Historical cash flow growth (12.5 percent weight)
  • Historical book value (12.5 percent weight)

To evaluate the value characteristics of a stock, Morningstar looks at:

  • Price-to-projected-earnings ratio (50 percent weight)
  • Price-to-book ratio (12.5 percent weight)
  • Price-to-sales ratio (12.5 percent weight)
  • Price-to-cash-flow ratio (12.5 percent weight)
  • Dividend yield (12.5 percent weight)

The high weighting assigned to earnings-related data shows that Morningstar believes earnings to be the most important criteria for evaluating the style of a stock.

Interestingly, Morningstar's mutual fund "style box" analysis take a markedly different approach.  For its style box analyses, Morningstar considers just two metrics: the average price/earnings ratio and the average price/book ratio of each fund.  The two components  are weighted equally.

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