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Value, growth and blend: Understanding investment styles

Marco Caprotti  |  18 Oct 2021Text size  Decrease  Increase  |  
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Morningstar readers often find references to “value” or “growth”. It is a way that investment professionals identify the styles towards which the investment instruments are oriented.

What do these terms mean, and how are the styles different from each other?

Understanding value vs growth

‘Value’ stocks are those that are seen to trade at a lower stock price relative to the company fundamentals. These stocks have low market valuations in relation to some multiples, such as:

  • Price / Earnings
  • Price / Book value; or
  • Price / Cash Flows.

These companies also tend to, on average, pay higher dividends. Some examples include companies like Enel, Total, Telefonica or JPMorgan which, although belonging to different sectors, ‘value’ as a common denominator.

On the other hand, ‘growth’ stocks are stocks that are expected to grow at a higher rate than the market and have higher multiples of the market average, based on the ratios cited above. These higher valuations are generally justified by higher rates of expected growth in sales, earnings or cash flows. Companies in sectors such as technology or healthcare (typically growth sectors) tend to fall into this category.

The split also applies to the investment styles of funds. In this case, however, a third segment must be taken into account: the blend funds.

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What are 'blend funds’?

Blend funds are managed funds (or exchange-traded funds) that invest in both value and growth stocks. The objective of this type of fund is to help diversification by spreading investment and risk control opportunities over both solid and quality companies that have a market value lower than that of competitors (value), and on companies that promise a fast growth of the business and of the value on the list (growth).

Three distinct styles

There are three different investment styles when it comes to funds:

  • Equity funds that adopt a Value style select well-established companies in the sector to which they belong. In most cases, they are large caps that have low debt and growth forecasts in sales, and dividends that are consistent over time.
  • Equity funds that use a Growth style select stocks in sectors with strong growth potential, and companies that guarantee high profitability regardless of debt. Often these companies do not distribute dividends or, if they do, the payout ratio (or the number of dividends paid to shareholders) is very low compared to the company's net profits.
  • Blend style equity funds do not adopt a specific investment style (Growth or Value). In this case, the manager, depending on the market situation, can make a choice of style by taking a clear direction towards Growth or Value, but can also not choose by keeping the portfolio bar halfway between the two.

What funds actually do, not what they say they do

A funds name may not always reflect the risk and return profile of the securities it holds. For this reason, Morningstar introduced the Style Box, a nine-box matrix that is the synthesis of a fund's portfolio analysis. It allows for informed comparisons and portfolio construction based on what stocks funds actually hold, rather than on assumptions based on a fund’s name or other factors.

The style box represents the portfolio's style (value, blend, or growth) and the median size of its holdings (large-, mid-, or small-cap); for bond funds, it represents duration, or interest-rate sensitivity (short, medium, or long), and credit quality (high, mid, or low).

The darkened square details where the portfolio’s ‘centre of gravity’ is, in terms of its style and market cap characteristics.

Morningstar Style Box

Funds and ETFs are classified considering the same logic and on the basis of the portfolio stocks, in order to make them comparable. For example, an instrument that invests mainly in Australian stocks with large value capitalisation, will not simply be an “equity Australia”, but will also be characterised from the point of view of style - Equity Australia large-cap value.

è Giornalista di Morningstar in Italia.

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