JULY 2019

The Performance of Value vs Growth: Look at Per Share Earnings and Free Cash Flow Growth

Category: Investment Research, Managing Directors, Portfolio Management

By Erick Rawlings, Managing Director, Research 

There’s much discussion in the financial press about the significant divergence in performance between “growth” and “value” stock investing and how growth’s significant outperformance over value in the current bull market is seemingly at odds with history which has shown that value tends to outperform over the long-term.

As allocators we are generally agnostic to the approach of value versus growth investing. But what we are is curious and we wanted to see if we could find an explanation as to why growth is currently outperforming value.

To help us answer this, we went back to one of our core assumptions which is that over the long-term, share prices should follow per share earnings growth, and per share earnings growth should follow per share cash flow growth.

Applying this, we used FactSet data to compare the performance of the Vanguard Value ETF (VTV) and the Vanguard Growth ETF (VUG) to the aggregate per share earnings and free cash flow growth of their underlying holdings. Since our assumption is based on the long-term, we reviewed data from January 2005 through December 2018.

As shown in the table below, what we found is that the historical divergence in performance between growth and value seems to be largely explained by the divergence in their per share earnings and free cash flow growth. That is, it seems to us that growth and value have earned their returns.

Source: FactSet

This analysis says nothing of the future and it isn’t an argument that growth will always outperform, or that value is “due” to outperform, or growth to underperform.

For us, this analysis helped us have a better understanding of perhaps why over the long-term the differential in performance occurred and it reinforced our emphasis of understanding potential per share growth in earnings and cash flow of our fund managers’ holdings, over being dogmatically biased toward value or growth.

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