Growth vs. Value, from Victor Niederhoffer and Tom Downing
I have written extensively about my belief that growth beats value, because my experience with many hundreds of companies shows that you get paid for finding areas where capital has a high rate of return, and for doing innovative things. You don't get paid for using capital with low rates of return and imitative enterprises. I like to give the anecdotal example of Joe McNay, who took part of Yale's endowment from a few million to over $125 million in 20 years, as unobtrusive evidence supporting my view. Also, since 1960, Value Line has tried to find groups of low P/E and low P/B stocks that would beat their composite, but found that a dollar invested in their composite or their Group 1, rebalanced each month, grew at least 10 times faster than a dollar invested in value over the period.
There are some problems in this, in that the Value Line composite, is an equally weighted geometric average, (the return on portfolio at time t is equal to the nth root of the cumulative product of the relative returns P[t]/P[t-] of the n stocks), and the portfolio may be arithmetically averaged. In this case the average would always be greater for the arithmetic workings over the geometric workings for the same data.
Anyhow, I based my empirical conclusions on the Value Line findings, and pay no attention to the results of Fama-French and their followers, which are fatally flawed by data problems, retrospection, non-operational results, and data ending in 1999. Almost seven years have passed since 1999 and it is now time to update the prospective Value Line results.
% Returns
Year Value Line Low Market Low Price Low Price Low Price Comp Cap Earnings Book Sales
2000 -9 -24 -47 -33 -26
2001 -5 32 -19 10 22
2002 -29 -32 -50 -39 -29
2003 37 62 54 71 59
2004 12 6 4 14 16
2005 2 -9 -7 -7 -2
2006/Sep 3 30 14 26 3
Total -1 40 -63 4 38
We have in this data the unfortunate feature of a theory meeting a fact. The results show clearly that during this period low P/S was best and low P/E was worst. Low Market Cap was best of all by a thin margin, but because these stocks would have suffered from transaction and liquidity costs, they are only slightly more meaningful than the seriously flawed studies of my former colleagues alluded to above.
Professor Pennington offers:
This is correct about the method used by Value Line to calculate the daily returns of their composite index. However, that's a very bizarre quantity to calculate, and it has no relation to a real portfolio that anyone could hold. Here are the problems:
- If any one stock goes to zero on day t, the entire portfolio would show a 100% decline! Surely that must have happened at some point over the last ~40 years of Value Line's existence, covering more than 1000 stocks. What did they do?
- They write that "This market benchmark assumes equally weighted positions in every stock covered in The Value Line Investment Survey. That is, it is presupposed that an equal dollar amount is invested in each and every stock.", but that's plainly not the case. Let's do a simple example involving just two stocks. One goes up 1% and the other goes down 90%. Value Line's formula would tell me to take the square root of 1.01*0.1, giving 0.32, corresponding to a 68% decline. An portfolio with an equal dollar amount invested in each stock would have declined about 44%.
- Not only are the weightings not equal, but also they can not be known in advance. You don't know the weightings that will be used until you know what the returns are.
- As Tom pointed out, and as illustrated in example 2 above, the calculated daily percentage changes using this method will always be less than the return of an equal weighted portfolio.
Here is text from the Value Line site.
Larry Williams replies:
I was always perplexed by Vic and Laurel's comments on growth vs. value, as my studies suggest that in the large blue chip stocks, DJIA, value outperforms growth hands down. The studies are backed up with actual performance from 1999 forward that beat the S&P and Dow.
Finally I reconciled it, in that Vic and Laurel are not looking at blue chippies, which have been my focus. There, growth is more difficult to come by, I suspect, so value leads the way. And I'm still learning about all of this.
Dr. Kim Zussman adds:
Out-of-sample testing should be powerful. However there are still fog issues with:
- Growth and value may go in-and-out of favor, and 00-06 (post-huge growth period) may partially attribute to this. Perhaps G > V over long periods, but sub-periods swing both ways.
- V.L.'s particular take on growth may be getting arbed out, with their publication of stock lists, F.V.L. closed end fund, and countless traders/funds using their data. i.e., the anomaly died.
Russell Sears mentions:
If the companies are reacting to incentive, it would make sense that they buy market share at the expense of profits, when growth is being rewarded in the markets, and do the opposite when value is being rewarded. Which comes first, and hence is predictive?
Steve Ellison adds:
Most companies are growth companies first and value companies later, after their industries mature and products become commoditized, or as a result of company-specific difficulties. Buying market share at the expense of profit actually heralds the end of growth, as it indicates the company is having difficulty differentiating its products from competitors' products.
From management's perspective, simply being in the value stock category is a slap that conveys an urgent need to improve profitability. One incentive is the possibility that management might be ousted in a takeover if the share price is low enough to attract a buyer. The generally high profit margins of growth companies provide incentives for competitors to enter the market.
Russ replies:
While this explains it on an individual company basis, I don't think it explains it on a total basis, as the graph Gordon sent suggest. What are the signs that this is happening at a macro level?