Don’t Give Up the Growth Ghost, but Diversify

The Dow Jones industrial average hit another record high last week, but managers of growth stock mutual funds have not been in a partying mood.

Dragged down by the once-mighty health care industry and by stumbling stars such as Philip Morris, growth stocks and the funds that own them are again trailing their value-oriented rivals this year--after a laggard year in 1992.

But this isn’t to say that investment advisers are giving up on the growth approach, which has an enviable long-term record. In fact, many suggest you should maintain holdings in both the growth and value camps because it’s hard to predict how long a particular style will remain in favor.

“You can’t afford to be out of either area because you can’t afford to miss a big move,” says Stephen A. Mutuszak, a Scottsdale, Ariz., investment adviser who specializes in no-load mutual funds. “When you see the NASDAQ rising faster than the Dow, that’s a sign that growth is recovering,” he says.

Ross Levin, a Minneapolis financial planner and president of the International Assn. for Financial Planning, agrees that investors should have both growth and value holdings, as well as those defined by large, intermediate or small companies. “Returns have really flip-flopped, and what’s been out of favor one year often leads the next,” Levin says.

He suggests rebalancing your portfolio periodically by bleeding money from your more successful equity funds into less successful ones.

Growth investing is an approach that focuses on identifying companies with the potential to boost profits. Value style emphasizes underpriced firms and stocks paying high dividends. Value companies often are clustered in cyclical industries, whereas growth stocks are typically found in businesses with steady or improving fortunes.

Because of their greater perceived potential, growth companies typically sell at higher price-earnings multiples and thus exhibit greater volatility--as was exemplified by Philip Morris’ 23% one-day nose dive last month.

The growth-versus-value tug of war tends to run in long cycles, with one style predominating for anywhere from two to seven years at a stretch. From 1989 to 1991, large growth stocks nearly doubled the performance of large value stocks. They appreciated 25.7% a year on average, compared to 13.3% for large value stocks, according to Wilshire Associates of Santa Monica.

But from 1981 to 1988, value companies rose at an 18.4% annual clip, compared to 10.9% for the growth stocks.

There’s no telling when the current trend favoring value stocks might end. “I’m telling our investors to expect a choppy year,” says Rocky Barber, president of William Blair Mutual Funds, a growth-oriented group based in Chicago.

The prospect of higher taxes and increased government regulation under President Clinton--in the form of price controls on pharmaceuticals, for example--has undercut the enthusiasm for growth stocks, Barber says. “We think of many growth stocks as having franchises, and if you get government intrusion, the value of those franchises could go down.”

Warren Lammert, who manages two mutual funds for the growth-oriented Janus Group in Denver, ascribes the under-performance more to the current state of the economy.

That is, as economic growth picks up, that would tend to favor cyclical companies more.

He adds that growth funds have been bogged down by problems unique to certain growth-oriented industries such as health care and tobacco.

In fact, some growth stocks have dropped so much lately that they’re now starting to appeal to value investors, Lammert says.

By contrast, he says, firms in certain traditionally cyclical industries such as railroads and banking are starting to look more like classical growth companies, with sustainable profit potential.

At any rate, growth investing isn’t dead but will eventually come back into vogue when the value theme runs out of steam, Lammert believes. “Over the long run, stock prices follow earnings, and that will tend to favor growth companies.”

Tale of Two Markets Growth stocks of all sizes are continuing to lag behind value stocks, as shown by the following performance results, which include both appreciation and dividend income.

1992 Return 1993 Return Stock Category (full year) (4 months) Large Value +14.39% +7.04% Large Growth +5.93% -6.81% Medium Value +22.62% +7.66% Medium Growth +12.28% -2.41% Small Value +29.23% +6.38% Small Growth +13.20% -2.41%

Source: Wilshire Associates