Could Value Stocks Finally Outperform Growth Stocks in 2024? (2024)

By Alexander Jones, International Banker

With interest rates likely to have already peaked in the current rate-tightening cycle that began around two years ago in the United States, the eurozone and other important jurisdictions, economies around the world find themselves at critical junctures in early 2024. With rate cuts expected to be implemented at some point during the year, equity investors are rightly wondering whether a change in strategy is required after such a long period of contractionary monetary measures being adopted by central banks. With that in mind, the age-old debate of growth investing versus value investing is worth revisiting at this pivotal moment. In 2024, will value stocks take the lead again after years of underperformance?

Growth stocks are equities of companies expected to have strong earnings in the future that will enable them to grow at rates significantly above the broader market’s. As such, while growth companies may not have impressive earnings at present, their potential gains over future years and even decades are deemed worthy of investment today by growth investors, who are willing to place high premiums on those future capital gains. This means that growth stocks can be expensive to purchase, although companies must demonstrate to investors key metrics associated with strong growth rates, such as consistent reinvestment of profits to boost growth trajectories.

That dynamic future growth story can often be attributed to a company delivering something new and/or innovative to the market, so tech start-ups typically tend to be sources of growth stocks, as are more mature companies with earnings-growth rates expected to continue outpacing the market. With any cash generated almost entirely committed back into the company, growth stocks seldom pay dividends to company shareholders.

Value stocks, meanwhile, are typically equities of companies with fundamental values not reflected by their share prices, with attractive value stocks tending to have lower price-to-earnings (P/E) ratios that are expected to rise once the market fully recognises such companies’ true worth. Such stocks can be found in undervalued companies that have fallen out of favour with investors—for example, following a broader market collapse—but continue to exhibit solid fundamentals, as evidenced by such metrics as dividends, debt-to-equity ratios and sales. With such companies trading at attractive discounts compared to their fundamentals, they should generate strong returns.

As currently priced bargains that previously demonstrated strong records, value stocks represent larger and more established companies than growth stocks. They also pay dividends more commonly than growth companies, as they don’t tend to reinvest all their retained earnings and may appear comparatively cheaper due to their undervaluations.

Comparing the two, growth stocks have mostly fared worse than value stocks during periods of rising interest rates, largely due to those higher rates more severely discounting companies’ future earnings to their present values (conversely, this goes a long way towards explaining why growth stocks performed so well in the years before and during the pandemic, when interest rates were at or near rock bottom in many economies).

But this trend did not hold true in the United States last year; despite rates rising sharply, growth outperformed value, especially among large-cap stocks. The Vanguard Value Index Fund (VVIAX), for example, returned 9.2 percent last year, whereas the Vanguard Growth Index Fund (VIGAX) generated a hefty 46.8 percent. Moreover, that outperformance has continued into 2024, with the same growth index gaining 1.3 percent more than the value index as of February 20.

Could this unusual performance flip simply be an outlier? According to Tom Hanco*ck, head of focused equity at Boston-based investment management firm GMO LLC, growth’s outperformance vis-à-vis value’s showing was mainly due to the success of mega-cap, artificial-intelligence-driven tech stocks. “This is an unusual environment where there are so many opportunities for large-cap equities,” Hanco*ck told CNBC in November. “You don’t normally see that.” Nathan Geraci, president of The ETF Store, meanwhile, added that a small concentration of large tech firms has been chiefly responsible for this exceptional situation. “A lot of growth performance this year has been driven by the so-called Magnificent Seven [Apple, Microsoft, Amazon, Nvidia, Meta, Tesla, and Alphabet] because if you look at many of the growth indices, they’re pretty top-heavy…. The largest growth companies have been enough to really drive that performance differential versus value.”

With value stocks lagging last year, could 2024 be their time to shine and take the lead from growth again? Some believe so, especially if rates begin to trend lower during the year, which may uncover beaten-down bargains in certain sectors. “Monetary policy normalization in many countries should further positively impact certain value-oriented sectors,” according to Franklin Templeton. “Higher interest rates have lured capital away from dividend-paying industries toward fixed income over the past year. For value investors, the drop in valuations in the consumer staples, utilities and real estate sectors, for instance, can create greater prospects of finding stocks unfairly trading below their fundamental value.”

Others are less convinced that interest-rate changes are significant determining factors, pointing to value being the historically more successful strategy. In a Bloomberg piece published on January 2, for example, opinion columnist Nir Kaissar described his research on growth and value stocks’ performances during previous interest-rate cycles dating back to 1954, with 12 periods of rising rates and 11 periods of falling rates counted. Kaissar, the founder of asset management firm Unison Advisors, discovered that value beat growth in 10 of the 12 periods of rising rates. But astonishingly, value also prevailed against growth in 9 out of the 11 periods of falling rates, meaning that value won in 19 of the 23 selected periods, or 83 percent of the time.

This strongly underscores that, irrespective of interest-rate directions, value has the edge over growth for the most part. Why is this the case? According to Kaissar, of the three main sources of stock returns—dividend yield, earnings growth and changes in valuation—value stocks have a “built-in edge” relative to growth through their lower valuations and higher dividend yields. “Growth hasn’t delivered enough earnings expansion historically to overcome value’s advantages, in large part because many growth companies never live up to their promise,” he added.

And with rates set to remain high, albeit declining, the precarious growth outlook will keep a lid on earnings growth throughout 2024. Indeed, J.P. Morgan Research’s mid-December projections see the S&P 500 (Standard and Poor’s 500) index registering subdued earnings growth of 2 to 3 percent in 2024, with earnings per share (EPS) of $225 and a price target of 4,200 with a downside bias. The US’ biggest bank also expects US growth to slow by the end of this year, with liquidity challenges remaining as central banks markedly shrink their balance sheets and borrowing rates remain restrictive across consumer and corporate segments.

“Absent rapid Fed [Federal Reserve] easing, we expect a more challenging macro backdrop for stocks next year, with softening consumer trends at a time when investor positioning and sentiment have mostly reversed,” Dubravko Lakos-Bujas, J.P. Morgan’s global head of US equity and quantitative strategy, noted. “Equities are now richly valued with volatility near the historical low, while geopolitical and political risks remain elevated. We expect lackluster global earnings growth with downside for equities from current levels.”

Against this backdrop, value stocks have a strong chance of outperforming their growth counterparts in 2024. “Based on our valuations, we continue to advocate for an overweight position in the value category, whereas growth stocks are trading at a slight premium to our fair values, and core stocks are valued near the market average,” according to Morningstar Research Services’ senior US market strategist, Dave Sekera, who sees growth stocks as now being largely overvalued. “However, there are still several stocks that continue to trade at a discount to our intrinsic valuations. As we forecast the rate of economic growth is poised to slow over the next few quarters, we prefer investing in higher-quality companies with wide economic moats.”

Broadening the scope beyond US borders may expose investors to more attractive value opportunities. “While we do see some US prospects, when we look at Europe, for example, we can find big globally competitive companies that are trading at compelling valuations and provide the potential opportunity for attractive future returns,” Franklin Templeton recently advised, citing Japan as a particularly appealing market for investors. “More and more Japanese companies are focused on improving returns on capital, raising prices amid higher inflation and are willing to take more risks to pursue faster growth—a marked change from the past few decades. The Tokyo Stock Exchange is also pushing reforms to get companies to raise their book values.”