This is Part 1 of a two-part blog post series on the market’s current expectations for U.S. growth and value stocks.
At the risk of making a 34-year-old pop culture reference, growth stock fundamentals beg the question first posed by Wendy’s: “Where’s the beef?”
As was the case in 1984, when war was declared on McDonald’s and Burger King, there appears to be a lot of “bun” in U.S. growth stocks but not a lot of “meat.”
Face it: the magnitude and duration of the multi-year clobbering of value strategies by growth stocks in the current cycle is second only to the legendary 1994–2000 “New Economy” years. That epic mania for growth as an investing style began about a year before the 1995 Netscape IPO,1 at which point the tech boom began to rage. That furious less-than-six-year rally in the second half of the 1990s took the S&P 500 Growth Index 400.7% higher (31.2% annualized), trouncing the S&P 500 Value Index’s gain of only 198% (20.2% per year).2 When the rug was ripped out in the 2000–2002 crash, value stocks picked up thousands of basis points of outperformance.
Today, the cumulative gap between the two indexes, which has been stretching out since 2006, is once again in triple digits. From July 31, 2006 to October 31, 2018—more than 12 years—the S&P 500 Growth Index returned 296% (or 11.9% annually), about doubling the 152% appreciation of the S&P 500 Value Index (7.8% annually).
That’s 144 percentage points.
Before we begin searching for The Beef, consider the striking picture painted by figure 1. As a reminder, the NASDAQ, about as “growthy” an index as can be constructed, started its crash in March 2000. The S&P 500 Index topped out later that summer. When they did, the rotation to value stocks was a flood.
Figure 1: S&P 500 Growth Total Return Index Relative to S&P 500 Value Index
Piggybacking on WisdomTree’s Prior Dividend Growth Work
We received positive feedback on our white paper, Dividend Growth’s Drivers: Picking Apart Quality, and this analysis builds on many of those concepts for the growth/value debate. In that piece, we looked at our Quality Dividend Growth suite, diving into the interaction of return on equity (ROE) with earnings retention and dividend payout ratios to determine the long-term drivers of shareholder wealth. The interrelationship between profitability and dividend policy is critical, and the more research we do on it, the more these concepts are becoming core parts of second-decade WisdomTree.
Figure 2 shows profitability and growth metrics for the S&P 500 Growth, S&P 500 and S&P 500 Value Indexes.
Figure 2: S&P 500 Growth, Core and Value Metrics
The Critical Equation
Dividend Growth’s Drivers: Picking Apart Quality identified profitability (ROE) as the driver of dividend growth, presenting the critical equation recreated in figure 3.
Figure 3: The Critical Equation
Figure 4 uses the critical equation to calculate “long-term” dividend growth for the three indexes. We added quotation marks to “long-term” because, frankly, looking into the future involves a lot more art than science.
Figure 4: Implied Dividend Growth Estimate
Can the S&P 500 Growth Index achieve long-term dividend growth of 16.8%? And how long is long-term? No one knows, including us. But we can engage the numbers to get a feel for whether we want to pay nearly 22x forward earnings for growth stocks when value stocks are on offer for 15x earnings.
In Part 2 of the blog post, we consider the possibility of multi-year 17% growth in dividends, and whether it even makes sense. Spoiler alert: it doesn’t.
Stay tuned for our suggestions for growth investing—namely ideas like the WisdomTree U.S. Quality Dividend Growth Index ETF (DGR.B), which tracks the WisdomTree U.S. Quality Dividend Growth Index CAD, and the WisdomTree U.S. Quality Dividend Growth Variably Hedged Index ETF™ (DQD), which tracks the WisdomTree U.S. Quality Dividend Growth Index Variably CAD-Hedged. For investors that want more of a switch in the direction of value stocks, one of our better yielders in broad U.S. equities is the WisdomTree U.S. High Dividend Index CAD, tracked by the WisdomTree U.S. High Dividend Index ETF (HID.B). The quality dividend growth indexes yield 2.7%, while the high dividend index has a yield north of 4%, putting them handily above the dividend yield on offer for the S&P 500 Growth Index.3
1The famed 1995 Netscape IPO is widely regarded as one of the first newsworthy events of the dot.com boom.
2Sources: Bloomberg, WisdomTree, 04/29/1994–03/31/2000. Unless otherwise stated, all returns in this blog in CAD.
3Sources: WisdomTree, Bloomberg, as of 11/15/18.
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