Buy value stocks, avoid growth stocks: Good Buy or Goodbye

In the latest edition of Yahoo Finance's Good Buy or Goodbye, Julie Hyman is joined by Interactive Brokers Chief Strategist Steve Sosnick to weigh the benefits of choosing to invest in value stocks over growth stocks, outlined by thematic performances seen in 2023.

"The Russell 1,000 value, which is what [the Vanguard Russell 1000 Value Index Fund ETF (VONV)] is based on, has a [price] of about 15... almost 16... so it's really not very expensive," Sosnick says on a value stock portfolio. "There is not a lot of downside from that regard. and the expectations for earnings are relatively modest. Call it about 5% is what that forward PE implies."

Alternatively, Sosnik looks to the Vanguard Russell 1000 Growth Index Fund ETF (VONG), believing stocks displaying continuous growth may be weighed down by economic headwinds.

"If everybody owns it, who is left to buy it? When you think about what has gone on, a lot of what we have seen in all markets, in almost every asset class, a year end phenomenon, if you're an institutional investment manager, FOMO is a real thing — it's fear, if you're an individual, don't succumb to FOMO," Sosnik says.

Click here to watch more Good Buy or Goodbye or you can watch this full episode of Yahoo Finance Live here.

Video Transcript

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JULIE HYMAN: It's a big, noisy universe of stocks out there. Welcome to "Good Buy or Goodbye," brought to you by E*TRADE from Morgan Stanley. Our goal, to help cut through that noise to navigate the best moves for your portfolio. And today, we're taking a look at value versus growth. I'm here again with Steve Sosnick, Interactive Brokers chief strategist. Thank you so much for being here. Appreciate it.

And your buy is valued, the Vanguard Russell 1,000 Value Index fund to be specific here. Now, I feel like the tale of growth versus value is a tale as old as time. But we'll talk about it again here today because it's worth talking about going into next year. So let's start with your bull case here on this. Valuation, you say, leaves some room to top expectations. In other, words expectations are low.

STEVE SOSNICK: Well, that's been the thing. And in this format, I always think like a long, short trader. So to me, this is my mentality about this. And these go together. The difference here is the value-- the Russell 1,000 value, which is what VONV is based on, has a P/E of about 15-- about 15, almost 16 than next year's forward P/E. So it's just about a little above 15.

So it's really not very expensive. The lowest it really has been at a year-end in the last few years has been 14. So there's not a lot of downside from that regard. And the expectations for earnings are relatively modest. Call it about 5% is what that forward P/E implies.

JULIE HYMAN: So they do better than that. It then leaves it room to top those expectations. Secondly, we're looking at a dividend yield-- and value tends to yield more. We're looking at dividend yield of 2.54%. So if you're looking at that versus the 10-year , there is a gap. The 10-year is still yielding more. But it's a gap that has shrunk.

STEVE SOSNICK: And that to me is a pretty compelling value. If you think about what-- everybody wants to earn returns on their cash. Now, in the case of a growth stock, the theory is that the companies can invest it in their high growth technology or whatever it is they're doing. In the case of a value stock, their prospects aren't necessarily as good, but they return the money to shareholders.

And so if you're getting 2.5% on yield and you'd have to go out and buy-- pay, 385, 390 to get a 10-year, that's not so terrible. It's obviously when you-- again, when you can get four plus in a money market fund, 2.54 doesn't sound great. But the money market fund has no chance of really growing. Whereas you have-- you do have some opportunity here in a value stock.

JULIE HYMAN: You can get price appreciation as well, which you're not going to get in the money market. And then a flip side of what you were talking about, first, is the P/E. You talked about the range that we've seen in the P/E for VONG.

STEVE SOSNICK: It's been relatively modest. It's been basically-- and I just did five-year year-end piece, figuring out what year end now. In the high 15s, which is where we are on a trailing basis, that compares reasonably well, again, as I said earlier, with its low of somewhere in the 14s. And its high somewhere around 18, 19. So you're not going to get the massive P/E expansion that you might get, but you also don't have a lot of downside price to be worried about if it falls.

JULIE HYMAN: Gotcha. Well, we always like to talk about what the risk to the bull case is. And in this case, I guess it's just that people don't like value very much.

STEVE SOSNICK: That's really what it is. I mean, investors have fashions, investments have fashions just like everything else. Value has been tremendously out of fashion this year. The growth index at least, again, using these Russell 1,000s, growth is up about 40%, 43% I think, value is up about 11%. And that 11% is pretty much all within the last two months.

So there's really has not been a lot of interest in value stocks. And Jared was out here talking about growth stocks. This is what people want to talk about. And so if that trend continues, value will underperform.

JULIE HYMAN: Well, let's talk about growth stocks, though. And let's talk about the flip side of the equation here and your goodbye, which is looking at the VONG. So the flip side of that, the Russell 1,000 growth. And so first of all, basically, it's the inverse of the other, that there are lofty expectations here being priced in.

STEVE SOSNICK: The P/E is about 31 and change and expected to go down to about 25, 26 as earnings improve. But that implies about a 15% earnings growth. That's a pretty high bar to match. Now, can these stocks do it? Even the Russell 1,000 is not as top heavy as the S&P 500, but those same top stocks do dominate.

But bear in mind something like Apple. Apple's had negative revenue growth quarter over quarter for four straight quarters. So there's a lot of growth priced into this. And I just picked on the biggest stock. The flip side, of course, NVIDIA has phenomenal growth priced in. So it all mixes up.

But if we are talking about a soft landing, maybe getting us 15%, and we talk about the potential for a hard landing, which is priced in certain quarters of the market, we're not getting 15% on a hard landing scenario here--

JULIE HYMAN: It's not priced in here. That much is for sure. The next thing is that it is-- and this is what-- when we talk about people being enamored of growth. It's a crowded trade. Now, you're really good at explaining things. So what is the problem with it being a crowded trade with a lot of people liking it?

STEVE SOSNICK: Well, the simplest thing is if everybody owns it, who's left to buy it? But when you think about what's going on, a lot of this-- what we've seen in all markets, in almost every asset class, there's been a year-end phenomenon. If you're an investor-- if you're an institutional investment manager, FOMO is a very real thing. It's fear. If you're an individual, don't succumb to FOMO. It's greed. That means you're just envious of somebody else doing better than you, and that's not a good way to invest.

But if you're an institutional investor, you have no choice. Because if everybody's doing better than you, that means you're doing worse and that means your job is at risk. So everybody needs to pile into the stuff that's winning. And they tend to-- we saw it last year where everybody piled out of the stuff that was losing, taking tax losses. And this year, it's been exactly the opposite.

Two years ago was a lot like this year, where we rallied hard into the end of the year. S&P 500 actually set the all time record high, which we've been on record high watch. That was the first trading day of 2022. And we never looked back. And so--

JULIE HYMAN: And we're about back to that level.

STEVE SOSNICK: --and so we're around there. So that's what the idea of a crowded trade means. If everybody is fully long these stocks, who's the marginal buyer?

JULIE HYMAN: We got to get on to--

STEVE SOSNICK: I'm sorry.

JULIE HYMAN: That's OK. So the downside in volatility, in other words, volatility has worked in investors favor this year, but it doesn't always.

STEVE SOSNICK: Well, as I mentioned, the growth stocks are up about 43%, the value stocks are up about 11% using the Russell 1,000. Over the two-year period, they're both about flat. So that means that the value is up about 1.5%, the growth is up about 3%. But bottom line is, for that volatility, you could have actually really left your money in the money market fund.

And what it's also telling us is that this phenomenal rally that we've seen in growth stocks this year was basically recouping what we lost last year. And so that is the volatility. And institutional investors like to think about volatility adjusted returns. Yes, it's great if you're making money. But if you're subject to a lot of volatility, that's not for everybody's taste. The value stocks have a lot less volatility. And over the longer term, they can provide you some return.

JULIE HYMAN: And then again, it's the flip side that investors just have loved growth. So they keep loving it, then it will continue to do well. And then finally, the chart that you've been alluding to here, the two-year performance here of value versus growth. And they've both gone a whole lot of nowhere.

STEVE SOSNICK: But look at the volatility in the purple line, which is the growth.

JULIE HYMAN: That we have definitely seen. I'm going to sum up what you have told folks here today. The case for value over growth. While growth has outpaced value this year, if you take a look at that two-year time frame, you see both performing very similarly.

So looking at where things stand now, you're telling investors, buy that Vanguard Russell 1,000 value index fund based on compelling dividend yield. Current P/E implying less downside and valuation leaving room to top expectations.

On the other side, you're saying, avoid the Vanguard Russell 1,000 growth fund. It's a crowded trade and there are lofty expectations in its implied earnings growth. Steve Sosnick, thanks so much. Really appreciate it. Happy New Year to you. Thanks for coming in to the studio. And thank you for watching "Good Buy or Goodbye." Tune in Tuesday. We've got an all new episode to start off a brand new year.