The table below lists the current and historical P/E ratios & CAPE ratios of Growth and Value stocks, calculated using Russell 1000 Growth and Russell 1000 Value indices. The trailing price-earnings ratio of growth equities is currently 39.61 and the corresponding ratio for value stocks is 21.72 (12/31/2020). The valuation spread between growth and value has not been this large since the height of the dot-com bubble of the early 2000s. The spread is even more significant when valuations are evaluated using the CAPE ratio.
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U.S. Growth & Value Stocks: P/E (TTM) & CAPE Ratios
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Growth & Value: Performance and Definition
Growth stocks have consistently outperformed value stocks since the financial crisis of 2007-2008. Especially the last few years have been very favorable for growth equities. The outperformance has been mostly driven by the IT sector and especially by the so called FAANG stocks (Facebook, Apple, Amazon, Netflix & Google/Alphabet). When using a longer-term horizon, it is easy to see that the market goes through multi-year cycles of different lengths in which either growth or value strategies outperform through the whole cycle. The speculation when the current cycle favoring growth equities will end has been going on for years but so far the believers of value have been disappointed time and time again. It remains to be seen whether the year 2021 will mark the return of value investing.
But how do you actually divide companies into growth and value segments? The common definition is that growth equities are companies that have demonstrated fast earnings growth in the recent years and are expected to keep growing their earnings significantly in the future. The higher potential for earnings growth justifies the higher valuation multiples the companies are trading at the moment. Also, the volatility of these stocks is higher and the volatility is expected and often welcomed by growth investors.
The narrative behind value stocks is that these companies have fallen out of favor for some reason and the true intrinsic value of these companies if not recognized by investors. These equities are trading at lower valuations than the overall market as their earnings growth outlook is considered gloomy at least for the short-term. The investment thesis is that as soon as these companies are able to deal with their short-term problems and challenges and realize their full earnings potential, investors will recognize their value and their past underperformance will transform into overperformance.
However, the classification of stocks into growth and value is not always clear and many high-profile investors have even questioned the meaningfulness of this whole division. A company might be classified as a growth stock using certain valuation metrics, but other valuation methods might indicate that the same company is clearly a value stock. There is no classification system that is approved by all investors so the division is always subject to interpretation.
Maybe the most followed indicators for the performance of growth and value equities are the Russell 1000 Value and Russell 1000 Growth indices. To create these indices, FTSE Russell is employing a multi-variable approach of various backward and forward-looking metrics to determine whether a company is part of the growth or value investment universe. All the constituents of these indices are selected among the Russell 1000 index components. Russell 1000 includes approx. one thousand of the largest public U.S. companies and represent over 90% of the market value of the U.S. equity market. An alternative for these indices is to use the S&P 500 Growth/Value indices that are maintained by S&P Dow Jones.