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Are Growth Funds Poised to Sprint?

The line between growth and value has blurred.

Karen Dolan, 11/07/2006

Is it time for value to hand the baton to growth? The contrarian in us wants to say yes. Morningstar's large-cap growth category has lagged every domestic diversified stock fund group more often than not during the past six years. Based on performance and the idea that value won't trample on growth indefinitely, it seems reasonable to conclude that large-cap growth funds are ripe for their turn at the head of the pack.

Hold on, though, while we examine a few crucial facts. Large-cap growth funds may indeed be due for a comeback, but as a group they are not screaming buys, according to underlying fundamentals. In fact, large-cap growth funds don't look drastically different from large-cap value funds in some regards.

A Look at History
Let's rewind to March 2000, the peak of the bull market. That was the point in time when large-cap growth funds looked most different from their large-cap value counterparts. The table below shows just how different, and by how much things have changed:

 Then and Now

Valuation and
Growth Metrics

Large-Growth
Category

Large-Value
Category
Large-Growth
Premium Over
Large-Value
Price/Earnings, March 2000
40.13
17.82
125.20%
Price/Earnings, Sept. 2006
21.05
14.89
41.37%
Price/Book, March 2000
8.13
2.86
184.27%
Price/Book,  Sept. 2006
3.70
2.37
56.12%
Price/Cash Flow, March 2000
27.67
9.95
178.09%
Price/Cash Flow, Sept. 2006
14.43
9.63
49.84%
Price/Sales, March 2000
4.51
1.19
278.99%
Price/Sales, Sept. 2006
1.98
1.31
51.15%
Earnings growth, March 2000
24.74
10.94
126.14%
Earnings growth, Sept. 2006
29.66
20.98
41.37%
Morningstar Data

We've come a long way since March 2000. Growth stocks have had a painful trek back to reality, and value stocks have enjoyed the market's favor. Sure, growth funds still hold more expensive companies today, on average--and some premium is warranted as companies that are growing faster should logically cost more. Yet the premium managers have to pay for growth is far less than it was at the peak of the bull market. Overall, valuations, such as price/earnings and price/sales ratios, have compressed, and the earnings growth differences aren't as profound as they once were.

Fishing in Each Other's Ponds
The parallels between value and growth portfolios aren't limited to aggregates and averages. They have been noticeable at the individual fund level, too. We're seeing skippers from both sides of the value/growth spectrum crowd around many of the same stocks. Take technology, for example. Value-minded funds that we like such as Dodge & Cox Stock DODGX and Schneider Value SCMLX have been scooping up shares of former growth darlings such as Dell DELL. Growth investors haven't necessarily given up on those very same stocks; Vanguard Primecap VPMCX and American Century Growth TWCGX have also purchased Dell shares recently. Other common tech picks include Oracle ORCL and Intel INTC.

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