Practical analysis for investment professionals
09 August 2018

Growth vs. Value: Waiting for GODOT

Is it time to start selling growth stocks and buying value stocks?

After the formers’ long run of outperformance, value stocks must be due for an upswing. Right?

These questions are on the minds of countless investors, so at the risk of making Samuel Beckett, winner of the 1969 Nobel Prize in literature, turn in his grave, I’d characterize our current predicament as “Waiting for GODOT (Growth’s Overdue Decline over Time).”

Growth vs. Value Performance: January 2009–July 2018

Growth vs. Value Performance: January 2009–July 2018

Since the end of the financial crisis, growth stocks have outperformed their value counterparts by 144%. But maybe that’s misleading because of the selective and short-term nature of the time frame.

If we extend the measurement period back, say, to the bursting of the tech bubble in March 2000, a different view of the relative performance of value and growth stocks emerges.

Growth vs. Value Performance: March 2000–July 2018

Growth vs. Value Performance: March 2000–July 2018

While historical return charts like the above are compelling, they don’t offer much insight into the likely future returns of value and growth stocks. Instead, we’re better off looking at a valuation chart. The graphic below depicts the forward price-to-earnings (P/E) ratio of growth stocks and value stocks using the Thomson Reuters Eikon database, with data extending back to January 2002.

Forward P/E Ratio of Growth and Value Stocks

Forward P/E Ratio of Growth and Value Stocks

What does this chart tell us? For starters, it shows how unusual early 2009 was in terms of relative valuation. Growth stocks were selling at valuations that were roughly comparable to those of value stocks. This was quite unusual since growth stocks have higher expected earnings and sales growth rates.

Indeed, since 2009 growth stocks have lived up to their moniker and generated higher earnings growth.

Earnings Growth since the Financial Crisis, January 2009–July 2018

Russell 1000 Growth Index: 84%

Russell 1000 Value Index: 30%

This demonstrates that their outperformance since January 2009 is not a fluke, but is the result of two factors in particular:

  • Growth stocks’ low valuation at the beginning of the period.
  • Their stronger earnings growth.

But an important question remains: Since growth stocks sell at a forward P/E multiple of 20.9 compared to 14.4 for value stocks, is the size of the valuation gap justified?

To answer this question, we constructed a two-stage dividend discount model based on the premise that there are two stages in a company’s life: Stage 1, wherein the firm retains most of its earnings and uses them to fuel an above-average growth rate; and Stage 2, when the company pays out a greater portion of its earnings as dividends and its return on equity converges to its cost of equity, resulting in a slower growth rate.

So what’s the purpose of this valuation exercise? We want to make a judgment only about the relative merits of growth and value stocks rather than the absolute valuation level of the market as a whole. By narrowing our goal, we can first infer the implicit assumptions in the overall market’s valuation and then modify those assumptions for the universes of growth and value stocks to determine their fair relative valuations.

The table below summarizes the assumptions. We lay out the rationales behind them in the Appendix. The last two rows of the table show the estimate of fair (or expected) P/E ratio in light of these assumptions and its comparison with the actual P/E ratio.

Fair Valuation Assumptions: Growth vs. Value Stocks

By comparing the estimated fair forward P/E ratio with the actual forward P/E ratios, we find that growth stocks look overvalued relative to value stocks even after taking their superior growth rate into account.


Although a significant proportion of growth stocks’ recent outperformance is justified, there is a legitimate case for favoring value stocks over growth stocks at this time.

Put another way, unlike in the Beckett play, when it comes to the stock market, GODOT won’t keep us waiting forever.


The P/E valuation equation implied by the two-stage dividend discount model is reproduced below, courtesy of Aswath Damodaran of New York University.

P/E Valuation Equation

The Stage 1 growth rate assumption is derived from the median I/B/E/S long-term earnings growth estimates for the Russell 1000, Russell 1000 Growth, and Russell 1000 Value indexes going back to 2002 from the Eikon database.

The dividend payout ratio for Stage 1 is based on current data as of July 2018. For Stage 2, the ratio is logically raised above the Stage 1 ratio. The exact number, however, is simply a judgment on our part.

Cost of equity is derived by combining the risk-free rate of 2.9% based on 10-year Treasury bond yield and an equity risk premium of 5.1% as calculated by Damodaran.

The Stage 2 growth rate assumes that State 2 return on equity converges to the cost of equity and then multiplies it by the earnings retention ratio to derive the expected growth rate.

The length of Stage 1 is a balancing figure that allows us to equate the estimated fair P/E ratio of the broad market to be roughly equal to the actual P/E ratio of the broad market.

There is clearly room for judgment and disagreement about our assumptions. Moreover, the model is quite sensitive to changes in certain assumptions. Nevertheless, we believe this exercise will help us make more informed decision about value vs. growth stocks rather than simply guessing based on past performance.

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All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.

Image credit: Edmund S. Valtman, courtesy of the US Library of Congress

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About the Author(s)
Gautam Dhingra, PhD, CFA

Gautam Dhingra, PhD, CFA, is the founder and CEO of High Pointe Capital Management, LLC. He developed the firm's pioneering investment approach based on the concept of Franchise Quality, and under his leadership, High Pointe has built an enviable investment performance record. Dhingra served on the faculty member at Northwestern University’s Kellogg School of Management for two years. In this role, he designed and taught The Business of Investing course in the school’s MBA curriculum. His research interests include ESG investing and valuation of intangible assets. He holds a PhD in finance, with specialization in investments and econometrics, from the University of Florida’s Warrington College of Business. At Warrington, he taught two courses in securities analysis and derivatives.

11 thoughts on “Growth vs. Value: Waiting for GODOT”

  1. Kirk Cornwell says:

    There is always a case for value (read Arnold Bernhardt) but overvalued stocks can remain so for a generation (the same generation that’s waiting for value to be realized).

  2. Baris Tuncsiper says:

    As someone who is ignorant of the US market, I would like to ask whether if there should be a case for not taking the same cost of equity due to differences in B (total mcap of growth vs value relative to index, and additional risk related to size/business model/ etc. of growth stocks)?

    1. Ankit Dubey says:

      Can you pls explain on why growth and value stock should have same beta and therefore same cost of equity. Using same beta for growth and value stock imply same return expectations from the two classes of stock?

      1. Ankit

        Thanks for your comment.

        Please see my reply above to Baris’s comment. Also, I have found betas to be unreliable indicators of risk and therefore I am personally not a fan of using them for calculating cost of equity. We measure risk using a Franchise Quality approach which somewhat resembles Porter’s Five Forces model and have found it to be a better method for distinguishing companies and their risk.



    2. No doubt cost of equity can vary between growth stocks and value stocks. However, the monolithic grouping of growth and value universes would make me reluctant to come up with estimates of cost of equity for these two groups using aggregate data only. I think determining cost of equity estimates at the company level and then aggregating them would be a good enhancement of this paper, but it would require considerable effort.

      1. Baris says:

        A very very belated thank you for your reply

  3. Pierre Nirascou says:

    Hi Gautham,

    Thanks for this great article,

    Although, the proportion of companies that are already in stage 2 is likely to be higher in the value universe than in the growth one. Therefore, is the 2-stage model using the same length is a good indicator to estimate the Fair Forward P/E? Would like to hear from you on that matter.

    Nonetheless the conclusion and graphs are really interesting!

    1. Pierre

      You are right that more value companies are likely to be in Stage 2 than growth companies. A more useful corollary to that is that Stage 1 for growth companies is probably longer than for value companies. It is possible to extend this analysis by using the Fade Factor whereby you gradually decline the current growth rate over time until it reaches a maturity equilibrium. Such a modification would naturally improve the standing of growth stocks over value stocks.

  4. Alan Underdown says:

    The article states that, in 2009, growth stocks were trading at valuations similar to value stocks. I think a value investor would say they were better value for the money at that time, and were actually the value stocks . As a value investor, I don’t use the definitions of growth and value stocks used to define these types of indexes. I hesitate to provide the oft-repeated quote of Warren Buffett to the readers of the CFA blog; but perhaps it will be of benefit to some newcomers, so here goes: “Growth and value are two sides of the same coin.” Buffett also said something to like growth and value are joined at the hip.

  5. john says:

    Most companies have no real investment opportunities at attractive rates of return at the margin, and way fewer have any opportunities in size. That’s the whole story.

  6. christian renato lazo says:

    As per YahooFinance, the 10-yr. rate is:.9690, but good article, though.

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