By Alexander Green Most investors realize that nothing outperforms a portfolio of common stocks over the long haul. (Not cash, not bonds, not real estate, not commodities nor precious metals.)
This assumes, of course, that you reinvest your dividends and stick with the program during the down times, two rather significant “ifs.”
However, it’s important to note that different classes of stocks give very different returns.
For example, Bank of America did a recent study and found that since 1926, growth stocks – companies with faster appreciation in earnings per share – returned an average of 12.8% annually. But value stocks – companies that are inexpensive relative to sales, net income and book value – generated an average return of 17% over the same period.
Compounding at these rates, $10,000 invested in growth stocks would be worth $194,294 in 25 years. The same amount invested in value stocks would turn into $506,578.
The difference is not insignificant. Value beats the heck out of growth over the long term.
Yet as I reported in my last column, value investing is on the wane. Goldman Sachs even recently called it “dead.”
Why? Because over the past decade, the performance of U.S. growth stocks has been almost three times better than that of value stocks. Index fund giant State Street Global Advisors calls it “the longest period of underperformance for value since the late 1940s.”
Morningstar reports that investors have pulled $116 billion from U.S. large-cap value funds over the past 10 years. More than a quarter of that outflow has occurred over the past 12 months.
Every asset class moves in up and down cycles, of course. There is no reason to believe that value won’t outperform again in the future.
So why are investors bailing out of the long-time champion wealth creator at precisely the wrong moment?
Blame it on what psychologists call the “Recency Bias.” This is the tendency of investors to extrapolate recent events into the future indefinitely.
When technology and internet stocks were hot in the late 90’s, for example, investors began talking of a “New Era” of limitless technological growth.
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Technological innovation does tend to increase steadily. Alas, the same cannot be said of technology stocks.
Years of rising prices lulled investors into a false sense of complacency. And when the dot-com bust came the technology-laden Nasdaq index lost over three-quarters of its value – and took a full decade and a half to recover.
The lesson? Buying value stocks is far smarter and safer than chasing the hot sector du jour.
Buy a stock at the right price and not only is your upside greater. Your downside is less.
The key is to avoid “the value trap.” This is the mistaken notion that, for instance, a stock that was trading at $50 but now sells for $20 is a “value.”
It is indisputably “cheaper.” But only time will tell if it was a genuine value.
Personally, I’m not interested in middling companies with flat sales, thin margins and declining profits. I’m happy to leave “deep value” and “vulture investing” to specialists with far greater appetites for risk.
I’m more …read more
Source:: Investment You
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