Why ‘value’ and ‘growth’ share categories are meaningless

Two experts express discomfort at the traditional growth and value stock definitions, because they say nothing about the future.
The post Why ‘value’ and ‘growth’ share categories are meaningless appeared first on The Motley Fool Australia. –

As the world navigates to the post-COVID era, the money has moved from growth to value stocks.

To demonstrate, the S&P/ASX All Technology Index (ASX: XTX) has lost more than 12% off its 52-week high. Meanwhile, the S&P/ASX 200 Index (ASX: XJO) has hit new all-time highs in recent weeks, shooting up more than 10% since the start of 2021.

The wisdom seems to be that as the economy picks up after the pandemic malaise, inflation will head upwards. Higher inflation can lead to higher interest rates, which are anathema to growth shares relying on future earnings.

But Montgomery Investments chief investment officer Roger Montgomery rejects the traditional categorisations of ‘value’ and ‘growth’.

“The conventionally accepted method of classifying value and growth stocks is subjective, arbitrary and engineered for convenience,” he said in a company whitepaper.

How ‘value’ and ‘growth’ definitions are flawed

Value and growth classifications are often made on a company’s price-to-earnings (PE) ratio. Sometimes analysts use price-to-sales to better reflect fast-growing businesses that don’t have massive earnings yet.

Growth stocks tend to have high ratios and value shares have low ratios.

REA Group Limited (ASX: REA) is an example of this. The online real estate advertising company’s PE ratio is now more than 158 after the stock price went from under $10 eleven years ago to $166.70 after close of trade Tuesday. 

Even though banking shares have rallied in the past 6 months, a value share like National Australia Bank Ltd (ASX: NAB) is still selling at a PE ratio of just 20.5 at the time of writing.

And the growth story of 2020, electric car maker Tesla Inc (NASDAQ: TSLA) currently trades at a PE ratio of more than 608.

According to Montgomery, this is problematic.

“Classifying growth and value stocks purely on PE ratio or some other market multiple is flawed,” he said.

“Stocks with high PE ratios can be value stocks and stocks with low PE ratios may have them for a very good reason.”

Shares with massive PE ratios can also be ‘cheap’

Forager Funds chief investment officer Steve Johnson last month shared Montgomery’s discomfort about these traditional definitions.

The trouble is price-multiple calculations tell investors nothing about the upcoming potential of a business.

“‘Rocket to the Moon’ trades at 40x earnings, therefore it is expensive: It’s a lazy conclusion,” Johnson posted on Livewire.

“And it can be very wrong.”

Johnson said a business that keeps growing for many years can make current PE ratio judgments look absurd.

It’s yet another investment lesson on the impact of compounding.

“When a company compounds earnings exponentially, the fair value can be a seemingly absurdly high multiple of early-year earnings,” he said.

Cochlear Limited (ASX: COH) is one example Johnson cited, admitting that he dismissed it years ago based on its high PE ratio.

Two decades ago the stock was going for around $35 to $40, meaning a PE ratio of more than 30. According to Johnson, Cochlear has grown 15% per annum since then.

The stock closed Tuesday at $232.75.

“With the benefit of hindsight, you could have paid 150 times earnings and have still generated a 10% annual return (including dividends).”

The post Why ‘value’ and ‘growth’ share categories are meaningless appeared first on The Motley Fool Australia.

These Dividend Stocks Could Be Your Next Cash Kings (FREE REPORT)

Motley Fool Australia’s Dividend experts recently released a brand-new FREE report revealing 3 dividend stocks with JUICY franked dividends that could keep paying you meaty dividends for years to come.

Our team of investors think these 3 dividend stocks should be a ‘must consider’ for any savvy dividend investor. But more importantly, could potentially make Australian investors a heap of passive income.

Don’t miss out! Simply click the link below to grab your free copy and discover these 3 high conviction stocks now.

Returns As of 15th February 2021

More reading

2 ASX 200 blue chip shares named as buys

2 quality ASX dividend shares rated as buys

5 things to watch on the ASX 200 on Wednesday

ASX 200 rises, EML up, Ansell announces CEO

These 3 ASX 200 shares were among the biggest movers today

Tony Yoo doesn’t own any shares mentioned. The Motley Fool Australia’s parent company Motley Fool Holdings Inc. owns shares of and has recommended Cochlear Ltd. and Tesla. The Motley Fool Australia has recommended Cochlear Ltd. and REA Group Limited. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

Trade The World Anywhere & Anytime!

Mobile app platform with over 50,000 global listed securities across 12 markets (over 70% global market capitalisation), right from your Android or iOS device.

Integrated with exclusive trading idea and investment analysis tools to help you find actionable insight on virtually every financial instrument across our 12 global markets, to help you optimise your trading strategies.

Refer Your Friends

Tell your friends about Monex and gift them FREE access to our trading tools.

We respect your privacy and will only send this one email notification to your friends. 

Share With Your Friends

Share on facebook
Share on twitter
Share on linkedin

Monex Trading Tools Access and Usage Terms

The Monex Trading Tools (referred to as ‘tools’ hereafter) are available to you inside your client portal;

To activate access to the tools, you must have a verified and approved trading account and have made a deposit of at least AUD $1000.

An active and funded account with a positive trading balance is required to continue to have access to the tools;

Although the tools are available to you indefinitely, Monex Securities may at it’s discretion disable access to the tools in the future;

Monex securities reserves the right to change these terms and conditions from time to time, as it sees fit, without notice.

Important Notice
iOS & Android App - 12 International Markets & Over 70% Global Market Cap. $0 Brokerage On US Trades. Click Here!