Line Blurs Between Growth, Value Stocks

The debate over which style of stock-picking is superior -- value or growth -- has been vigorously contested in the investing world for years. There are numerous studies that show value stocks tend to outperform growth ones over the long haul. But there are also periods when growth offerings have had their time in the spotlight.

Investors who make a choice of one over the other are usually trying to gauge which style the market will favor. They gradually ratchet up one while cutting back on the other until the market changes course. Then, the opposite happens. Making a prediction on the direction of the stock market is never a simple task. Just ask all those investors who got burned when supposedly growthy Internet stocks fell off a cliff at the end of the last decade.

This year, in particular, it's been extremely difficult to judge which style of stocks is the better bet -- and, by proxy, which are the better mutual funds and ETFs to own. As the credit crisis has taken hold of the market, thousands of stocks and funds have been beaten down to tantalizingly low levels. In the process the distinction between growth and value has become one without any real difference. According to Lipper, the Russell 1000 Growth and Value indexes traded at 43.6 and 23.2 price/earnings ratios in early 2002. That gap has since shrunk to 13 and 11.9 multiples. That situation begs the question: Should investors really be worrying about which side of the investing fence they are sitting on?

"I have tilted portfolios one way or the other in the past," says J.D. Steinhilber, founder of AgileInvesting in Nashville. "But I am not doing so currently. In a market environment like this where everything has fallen so much I would be hesitant to say certain sectors are likely to recover before others."

We have always stuck to elementary definitions when it comes to describing the differences between value and growth stocks. On the one hand, value stocks usually have a low price/earnings ratio and a share price that's trading at a deep discount to its normal range or a specific target estimate. Growth stocks, though, usually change hands at pricey multiples and at rich prices because investors bet they will grow faster than the rest of the market.

The problem in 2008, though, is that the two groups aren't sticking to the script. A perfect example of this is technology, an industry that's a traditional bellwether for growth investing. According to Morningstar, Hewlett-Packard (HPQ: 37.61, -0.51, -1.33%) is trading at a slight discount to the S&P 500 despite a relatively healthy growth outlook for the printer and PC maker. Microsoft (MSFT: 23.35, -0.44, -1.84%) has become a top holding in the well-regarded T. Rowe Price Value fund (TRVLX). Meanwhile, American Century Growth (TWCGX) has a decent helping of energy stocks in its portfolio (at least at its last filing date). Value investors can argue that sector has traditionally been one of their favorites, long before it took off the last few years. A similar situation is playing out in financials, where dozens of growth and value managers alike are buying the same stocks in anticipation of a rebound.

What's more, the stock market hasn't discriminated this year. It's whacked all kinds of stocks and funds, regardless of what style or company size they may be labeled with. It's hard to argue in favor of growth or value when both are down more than 40% this year. Investors are losing money either way.

But what about 2009 or 2010? One of the attributes you will hear about growth sectors like tech or health care is that they tend to do well during slow-growth periods. That's because investors seek out stocks whose earnings are (potentially) growing at a faster pace than their contemporaries. In the ensuing buying frenzy the share prices increase. Again, we aren't so sure that scenario will play out this time around. The U.S. is dealing with a financial system in tatters, a battered housing industry, a new presidential administration, two wars and the tailspin of its automobile industry. In that kind of an environment it's tough to predict which stocks come out unscathed.

Advisors, though, say the best protection is to keep your portfolio simple, don't make any knee-jerk reactions or Hail Marys on risky stocks and, most important, stay diversified. If you're investing using ETFs, make sure you do homework on the construction of the underlying indexes.

"The traditional distinctions blur when you get into these different indexes because it all depends on the methodology," says Steinhilber, who uses ETFs extensively at his investment shop. "Everything has been destroyed to a certain degree. [It's best for investors] to clean up their portfolios, keep expenses low and look for opportunities."

Two of the gold standards for growth and value investing are the individual sleeves of the Russell 1000. The iShares Russell 1000 Growth (IWF: 41.15, +0.04, +0.09%) and the iShares Russell 1000 Value (IWD: 47.25, -0.17, -0.35%) are the ETFs based on those slices. Together, the funds hold almost $20 billion in assets.

A new option we're keeping our eye on comes from WisdomTree. This ETF provider recently filed with the SEC to launch WisdomTree LargeCap Growth (potential ticker: ROI). WisdomTree is known for its indexes based on dividends. This fund, though, will take a little bit of a different tact. Instead of solely focusing on those payments, it will eventually own about 300 companies based on a mix of annual earnings per share growth, annual sales per share growth, annual book value per share growth and annual stock price growth. Companies will be weighted based on their earnings over the most recent four quarters. If successful, the fund could put a twist on the old growth vs. value debate.

Maybe the best way to stay above the fray, though, is to keep a toe in both camps. Indeed, to benefit from a growth or value rebound, all you need to do is be exposed to both styles. To help you make that decision, below we list details on two popular value ETFs and two popular growth ETFs, their costs, their holdings and their returns year to date.