Welcome to Charts that Count.
It's one of the oldest debates in stock market investing.
Is it better to own companies that
are generating lots of cash now and to buy those companies
cheaply?
Or is it better to own companies with great growth potential
that will generate lots of cash further into the future?
This is the debate known as value versus growth.
If you look at this chart you'll see
that the growth stocks have solidly outperformed value
stocks over the last decade.
$100 invested in the growth index
a decade ago has returned over $350
as tech stocks like Amazon and Apple have outperformed.
The same $100 invested in the value index,
which features cyclical stocks in banking and in energy,
has returned less than $250.
Why have growth stocks outperformed so spectacularly?
Part of the reason is that over the last decade
interest rates have fallen.
And when interest rates fall the discount applied to future cash
flows goes down.
In other words, lower rates means money tomorrow is worth
more, hence the outperformance of stocks
with great future growth potential.
Recently, however, the trend has reversed.
This is the same chart we just looked
at but over a much shorter time span, just a few months.
And as you can see, here, it's the value stocks
that have outperformed, returning
almost twice what the growth stocks have provided.
Interestingly, there are two almost opposite interpretations
of what this reversal may mean.
The first interpretation is optimistic.
The value stocks are outperforming
because of optimism about the performance
of cyclical stocks, again, such as banks and energy companies.
If the economy is going to continue to be strong,
then these cyclical stocks should do well.
The second interpretation is much more pessimistic.
On this view, the outperformance of value
of companies that generate more cash now
is a reflection of pessimism.
In other words, investors frightened
about the economic future are moving towards companies
that have the cash today.
What we have then is a case where
there's been a clear reversal of trend,
but the interpretation is anything but clear.