There’s never been a worse time in history to buy growth stocks, according to research by Eric D. Nelson, CFA and the founder of Servo Wealth Management.
In a recent article, Nelson points to data that shows the Fama/French US Value Index has outperformed the Fama/French US Growth Index going all the way back to 1927. The Value Index averages a 12.8% return per year compared to just 9.7% for the Growth Index.
Over the last 10 years, however, growth has prevailed. Nelson says the trend of growth outperforming value started in 2014 but really started picking up steam in 2017. The Growth Index has returned an average of 16% over the last 10 years. Meanwhile, the Value Index just returned with an average of 7.5%.
The last 12 months in particular have magnified this trend. It happened with value stocks actually declining and growth stocks rocketing even higher.
Nelson says the explanation for this is simple: growth stocks have become expensive.
“Growth stocks have gotten crazy expensive. Yes, that’s a technical term. Their prices have grown much faster than their fundamentals have improved.”
Today, the difference in price-to-book value of growth stocks compared to value stocks is the largest it has ever been. Also, it is just as “out of whack” as it was in 2000, says Nelson.
“Value is about as cheap as it usually is, and growth is as overpriced as it’s ever been. The above-average gains for growth stocks have pushed up their prices versus their fundamentals to levels we’ve never seen before,” he added.
So what does this extreme valuation disparity mean for growth and value stocks?
“It’s obviously not good for growth’s future prospects,” says Nelson, adding that the last time growth stocks were as expensive as they were today, the tech bubble burst in 2000 and growth stocks got wiped out.
“The next 10 years…were devastating for growth. Large growth stocks lost -11%, small growth stocks lost almost -14%. Large value gained +25% and small value gained over +192%.
“Want better value news? Consider that today, value stocks are even cheaper than they were in 2000!” says Nelson.
To back up his claim, Nelson looked at every rolling 10-year period since 1927. (1927-1937, 1928-1938, etc.)
Of the 1,100 10-year periods since 1927, only 77 times (or 7%) has the Fama/French US Growth Index outperformed the Fama/French US Value Index.
On those 77 occasions, over the next 10-year period the Value Index turned around and beat the Growth Index 77-out-of-77 times.
Nelson’s research shows the average return over the next 10 years climbed 8.3% higher for value stocks compared to growth stocks.
The best of those years saw value beat growth by 13% and even the worst of those years saw value beat growth by 2.9%.
“Smart investors know that it doesn't pay to buy more of what’s done well recently, especially if that area of the market (bonds, or large stocks, or growth stocks) is a segment with the lowest relative long-term returns. With that in mind, is now the worst time in history to pile into growth stocks and give up on value?
“It sure looks that way,” says Nelson.