Value vs Growth Investing

The debate between growth and value investing is a defining feature of modern finance. On one side are growth stocks—companies expected to deliver rapid earnings expansion. On the other are value stocks, which appear cheap based on fundamentals such as earnings, book value or cash flow. But which offers the better long-term return? And what should investors expect going forward?

Defining Growth and Value

Growth stocks are companies with strong future prospects, often reinvesting profits rather than paying dividends. They tend to have high price-to-earnings and price-to-book ratios. Classic examples include firms in the technology and consumer discretionary sectors, such as Apple, Amazon and Nvidia. These companies promise future profitability, and investors are willing to pay a premium today.

Value stocks, by contrast, are typically mature firms with slower growth expectations. They are priced lower relative to their fundamentals and often pay out more in dividends. Think of sectors like financials, utilities, and energy—companies such as JPMorgan Chase, ExxonMobil, and BP. These stocks may be undervalued due to temporary setbacks, pessimistic sentiment or cyclical concerns.

Why Value Might Outperform

Fama and French (1992) demonstrate that, historically, value stocks have delivered higher average returns than growth stocks. This finding, known as the ‘value premium’, has held across different markets and time periods (Fama and French 1998; Asness, Moskowitz, and Pedersen 2013). But why should this premium exist?

The Risk-based Argument

The classical explanation is based on risk. Value stocks are often more economically sensitive and financially distressed. They may underperform in recessions, making them riskier in a macroeconomic sense. To compensate for this risk, investors demand higher expected returns. This aligns with the logic of the Fama-French three-factor model (Fama and French 1993), which expands on the Capital Asset Pricing Model (Sharpe 1964; Lintner 1965).

Campbell and Vuolteenaho (2004) add nuance, arguing that value stocks are more exposed to ‘bad beta’—they suffer more when macroeconomic conditions deteriorate. For long-term investors, this means that value stocks can offer more return precisely because they are harder to hold during difficult economic times.

The Behavioural-based Argument

Another explanation is that the value premium arises from investor error, not risk. Lakonishok, Shleifer, and Vishny (1994) argue that investors systematically overpay for glamorous growth stocks and underappreciate the potential of unloved value stocks. This behavioural mispricing corrects over time, generating excess returns.

De Bondt and Thaler (1985) show that stocks with poor past performance tend to outperform those with strong recent returns—evidence of investor overreaction. Barberis, Shleifer, and Vishny (1998) suggest that investors use overly simplistic mental models, extrapolating recent growth trends too far. This causes growth stocks to become overvalued and value stocks to be neglected.

As John Cochrane wryly explains, when he asks students whether they would prefer to invest in growth stocks with lower expected returns or value stocks with higher expected returns, most instinctively choose value. But once he reveals that value stocks often include ‘crappy’ or out-of-favour companies—think traditional car manufacturers like Ford or oil giants like ExxonMobil—whilst growth stocks feature sleek, innovative firms like Apple and Tesla, the class quickly changes its mind. ‘There you go,’ he says, ‘that’s the value premium’ (Rational Reminder 2021).

What the Data Show

Despite the theory, real-world performance fluctuates. The early 2000s favoured value investing. But from 2008 to 2020, growth stocks—especially in technology—dominated. The rise of mega-cap tech firms like Microsoft and Alphabet reshaped index performance and left value stocks trailing.

Still, long-term evidence supports a value tilt. Arnott et al. (2021) show that value premiums have persisted over time and tend to be stronger following periods of market stress or extreme valuation spreads. Asness et al. (2020) argue that by the end of the 2010s, the gap between the valuations of value and growth stocks had reached historic highs—setting the stage for potential mean reversion. Indeed, a sharp reversal began in 2021, with the value premium rising to +22.2%, followed by an even stronger +31.7% in 2022 (Fama and French n.d.).

For those interested, Rob Arnott and the team at Research Affiliates have developed an excellent Asset Allocation Interactive tool, which allows investors to explore expected long-term returns across asset classes and styles. It offers a powerful way to assess expected long-term returns across asset classes and styles, and often highlights the attractive forward-looking return potential of value stocks—especially when valuation spreads are elevated.

Figure 1. This shows the expected annualised real returns (net of inflation) for the next ten years for different style equity strategies. ‘DM’ denotes the term developed markets and ‘Dev ex’ denotes the term developed markets excluding the US. Data taken from Research Affiliates.

Implications for Investors

So where does this leave long-term investors? According to John Y. Campbell, value stocks may be particularly suitable for aggressive investors with long time horizons (Rational Reminder 2023). These investors benefit from holding assets that retain their value when discount rates are high, enabling better reinvestment opportunities. Growth stocks, which are more sensitive to discount rate changes and less correlated with bad macroeconomic news, may appeal more to conservative investors.

This does not mean that an investor should choose only growth or only value. A blend of both—across sectors and geographies—can offer diversification, rebalancing opportunities and resilience across different market regimes. As I point out in my piece, ‘Factor Investing in Equities’, whilst the market portfolio (Mkt–RF) delivered the highest cumulative return over the full period (1973-2024), it’s important to recognise that it holds a significant allocation to growth stocks, which have historically underperformed value stocks in many long-term time periods. The value premium (HML) reflects the excess return of value over growth, and by tilting away from the market and towards value, investors can potentially enhance their long-term, risk-adjusted returns.

Figure 2. This shows the realised annualised real returns (net of inflation) for the past ten years for different style equity strategies. ‘DM’ denotes the term developed markets and ‘Dev ex’ denotes the term developed markets excluding the US. Data taken from Research Affiliates.

Conclusion

The growth versus value debate cuts to the heart of investing: should you chase the promise of strong future returns or hunt for higher expected returns today? Academic research leans in favour of value over the long term, though with considerable variation along the way. Whether driven by risk, mispricing or both, value investing has a strong empirical foundation. But success requires patience, discipline and an ability to withstand long periods when growth dominates.

For investors looking to increase their expected returns, maintaining some exposure to value may be a prudent and evidence-based choice.

References

Arnott, Robert, Campbell R. Harvey, Vitali Kalesnik, and Juhani T. Linnainmaa. 2021. ‘Reports of Value’s Death May Be Greatly Exaggerated’. Financial Analysts Journal 77 (1): 44–67.

Asness, Clifford S., Tobias J. Moskowitz, and Lasse Heje Pedersen. 2013. ‘Value and Momentum Everywhere’. Journal of Finance 68 (3): 929–985.

Asness, Clifford S., et al. 2020. ‘Is Value Investing Dead? Not If You Keep the Faith’. AQR Capital Management. https://www.aqr.com

Barberis, Nicholas, Andrei Shleifer, and Robert Vishny. 1998. ‘A Model of Investor Sentiment’. Journal of Financial Economics 49 (3): 307–343.

Campbell, John Y., and Tuomo Vuolteenaho. 2004. ‘Bad Beta, Good Beta’. American Economic Review 94 (5): 1249–1275.

De Bondt, Werner F. M., and Richard Thaler. 1985. ‘Does the Stock Market Overreact?’ Journal of Finance 40 (3): 793–805.

Fama, E. F., and K. R. French. n.d. ‘U.S. Research Returns Data (2x3 Factors)’. Fama-French Data Library. Accessed May 21, 2025. https://mba.tuck.dartmouth.edu/pages/faculty/ken.french/data_library.html

Fama, Eugene F., and Kenneth R. French. 1992. ‘The Cross‐Section of Expected Stock Returns’. Journal of Finance 47 (2): 427–465.

Fama, Eugene F., and Kenneth R. French. 1993. ‘Common Risk Factors in the Returns on Stocks and Bonds’. Journal of Financial Economics 33 (1): 3–56.

Fama, Eugene F., and Kenneth R. French. 1998. ‘Value versus Growth: The International Evidence’. Journal of Finance 53 (6): 1975–1999.

Lakonishok, Josef, Andrei Shleifer, and Robert Vishny. 1994. ‘Contrarian Investment, Extrapolation, and Risk’. Journal of Finance 49 (5): 1541–1578.

Lintner, John. 1965. ‘The Valuation of Risk Assets and the Selection of Risky Investments in Stock Portfolios and Capital Budgets’. Review of Economics and Statistics 47 (1): 13–37.

Rational Reminder. 2021. ‘Prof. John Cochrane: (Modern) Modern Portfolio Theory’ The Rational Reminder Podcast, 9 September. https://rationalreminder.ca/podcast/169

Rational Reminder. 2023. ‘Prof. John Y. Campbell: Financial Decisions for Long-Term Investors’. The Rational Reminder Podcast, 27 April. https://rationalreminder.ca/podcast/250

Sharpe, William F. 1964. ‘Capital Asset Prices: A Theory of Market Equilibrium under Conditions of Risk’. Journal of Finance 19 (3): 425–442.