Growth vs Value Stocks ​

By Jake Rickman​

What do you need to know this week?

Since November 2021, the MSCI World Growth Index has fallen more than 20% of its peak value. This index is primarily composed of so-called “growth stocks” like Tesla and Amazon.

Investment funds with a high degree of exposure to growth stocks, particularly those in the technology sector, have likewise suffered from a rough year: one fund has lost nearly 50% of its gains this year.

Why is this important for your interviews?

Some investors divide equities (“stocks”) into two categories: growth and value. Each behaves differently.

As their name suggests, in good times, growth stocks appreciate much more quickly compared to other equities. So, for instance, if the year’s average for the market is 5%, growth stocks might grow at 10%. Provided the market is soaring (as it has for the past two years), if you invest £100, the value of your investment will be £110. This £10 surplus is called “capital growth”.

In contrast, value stocks have a lower rate of capital growth. However, certain investors (called “value investors”) target them because they believe the company’s underlying performance is stronger than the market gives them credit for. The idea is, in the long run, value companies like eBay and Ford Motor are solid investments.

Additionally, value stocks tend to pay dividends (i.e., steady payments four times throughout the year) because they have dependable cashflows and steady profits. Companies characterised as growth stocks usually do not pay dividends, usually because they are not turning a profit or intend to reinvest their earnings.

Having a basic grasp of these two different forms of equity is itself useful if you are interested in funds or financial markets.

But it is also instructive to consider what the plummeting performance of growth stocks says about the wider market. The sell-off of growth stocks has coincided with a two-year central banking policy reversal, with the Bank of England and Federal Reserve raising rates to contain inflation.

We have looked at the effect of inflation elsewhere, but as it relates to the equities market: faced with a slowing market, investors become a little less giddy at the soaring face-value of growth stocks and begin to pay attention to the company’s underlying performance in the short term. Absent any dividend payments (because of uncertain earnings potential), investors pivot to the “safer” option of value stocks, which tend to be more established companies.

Does this foreshadow a wider economic crash? Not necessarily, but it could certainly suggest that the era of fast markets and high-growth tech stock may be slowing.

How is this topic relevant to law firms?

Lawyers advising clients on fundraising or equity capital markets (ECM) are expected to understand what certain changes in the market mean for their clients.