Value ETF Returns Come Alive

Are value stocks making a comeback? Are growth stocks falling out of favor?

It sure seemed that way in September, when value stocks outperformed their growth counterparts by the largest margin since October 2018.

The $52 billion Vanguard Value ETF (VTV), the largest value ETF on the market, climbed 3.5% during the month, sharply outperforming the $42 billion Vanguard Growth ETF (VUG), which rose a mere 0.3%.

It was an abrupt turn of events for the factors. Value stocks had been consistently underperforming growth stocks for years. The most surprising part about it was that the shift happened in a relatively benign month for U.S. stocks—the S&P 500 rose 1.9% in September—contrasting with prior periods of value outperformance, when the broader stock market fell sharply.

Trend Shift?

Value’s outperformance versus growth hasn’t extended into October. Month to date, through Oct. 29, VUG has returned 2.2%, just barely edging past VTV’s 2.1% gain. But there are those who argue September’s turnaround is a sign that value’s day in the sun is only just beginning.

The narrative is that value stocks (those with low valuations)have simply gotten too cheap compared with growth stocks (those with above average revenue or earnings increases).

Case in point: The price-to-earnings ratio for the S&P 500 Growth Index is 56% greater than the P/E ratio for the S&P 500 Value Index, the biggest premium since 2001. The difference is even more stark for the CRSP US Large Growth Index and the CRSP US Large Value Index, which underly VUG and VTV, respectively—a 91% premium for the growth index.

Startlingly, growth, as measured by VUG, has outperformed value, as measured by VTV, in eight of the past 10 years. In that period, VUG has returned 287.8%, compared with 209.3% for VTV. Even this year, after September’s value outperformance, VUG is handily beating VTV, with a 27.5% return versus 18.6%.

Premium based on P/E ratios for S&P 500 Growth Index and S&P 500 Value Index

Growth Outperformance Not A Surprise

All that said, perhaps it shouldn’t be too shocking to see growth outperforming value. After all, U.S. stocks are in the midst of a decade-long bull market. It’s only natural that investors would increasingly gravitate toward higher-risk, higher-reward stocks with growth characteristics as the bull market rages on.

That’s especially the case given that economic growth during this cycle has been relatively modest by historical measures. Average annual GDP growth of around 2.3% during the past decade is 1% below the longer-term norm. That puts a premium on firms that can grow in this environment.

What’s more, inflation and interest rates have also been well below historical levels, making future growth more valuable in discounted cash flow models.  

Tech Vs. Financials

Another factor that’s been fueling outperformance in growth versus value is sector tilts. Growth ETFs are predominantly made up of technology, consumer discretionary and communication services stocks. Those sectors make up a whopping 67% of VUG, but only 19.1% of VTV.

In contrast, VTV holds 47% of its portfolio in financials, consumer staples, energy and utilities—sectors that collectively make up only 8.2% of the growth-focused VUG.

For value to start outperforming growth on a sustainable basis, sectors like tech will likely have to fall out of favor relative to sectors like financials. Could that happen? Certainly. But there are secular trends in tech (the rise of cloud computing and artificial intelligence) and financials (low rates and flat yield curves) that could make that reversal difficult.

On the other hand, regardless of secular head winds or tail winds, perhaps tech has simply gotten too expensive relative to financials. After all, the last time value outperformed growth was in the years following the bursting of the dot-com bubble in 2000. While they were growing ferociously, tech valuations had gotten far too heated, leading to a long period of underperformance.  The iShares Russell 1000 Value ETF (IWD) and the iShares Russell 1000 Growth ETF (IWF) are the two oldest value and growth ETFs on the market, respectively, both coming to market in May 2000, around the time of the dot-com peak.

As can be seen from the chart below, returns for the value ETF have strongly outpaced returns for the growth ETF since that date.
 

ETF Options

Fortunately, regardless of where investors stand on the growth versus value debate, there are ETFs available to express those views. Broad market ETFs hold a combination of value and growth stocks, but for investors who want to increase their exposure to one of these factors, there are 67 value ETFs and 53 growth ETFs listed on U.S. exchanges.

Importantly, each fund targets these factors differently. Funds use different criteria to determine which value or growth stocks to hold.

The aforementioned VTV selects value stocks based on a combination of price-to-earnings, price-to-book, dividend-to-price and sales-to-price ratios. Meanwhile, VUG uses earnings-per-share growth, sales growth and return on assets to select its stocks.

VTV and VUG hold relatively broad baskets of stocks—around 300 names each. But other funds, like the Invesco S&P 500 Pure Value ETF (RPV) and the Invesco S&P 500 Pure Growth ETF (RPG), take a more focused view on what value and growth are.

The funds use similar metrics as the Vanguard funds to select value and growth stocks, but only hold those with strong exposure to the factors. That results in smaller portfolios of just over 100 stocks each.

Click around ETF.com’s value and growth channels to see what other funds are available.

Email Sumit Roy at [email protected] or follow him on Twitter sumitroy2