Debt Free

To the uninitiated it can be kind of confusing. Wouldn't you want both value and growth in your investments? Why can't you have both? Do stocks that are a good value not grow? If they don't grow, why not? Well, as with many things, with equity investments the nomenclature may not really describe exactly what's going on. Value stocks certainly can grow and growth stocks can be really good values. If you've been investing in the stocks market for a while, you're well aware what the different descriptors indicate.

While most people are familiar with the Dow Jones Industrial Average, there are many more stock indexes that aren't reported on the news every night, unless you are a regular to Bloomberg or CNBC. While the Dow Jones Industrial Average looks at only 30 different blue chip companies, there are other indexes that encompass different segments of the market.  The Russell 2000 is one widely used index for small cap (generally, stocks with market caps of under $2B or so, but over $300M) stocks. According to Russell: “The Russell 2000 Index offers investors access to the small-cap segment of the U.S. equity universe. The Russell 2000 is constructed to provide a comprehensive and unbiased small-cap barometer and is completely reconstituted annually to ensure larger stocks do not distort the performance and characteristics of the true small-cap opportunity set.” It is actually a subset of the larger Russell 3000 index, including the smallest 2000 stocks of it's larger sibling.

Another index that has gained considerable favor of investors over the past couple of decades is the S&P 500 index. The S&P 500 index was created by the brokerage firm Standard & Poors. It is viewed by many investors as giving a better picture of the actual U.S. stock market. The S&P 500 includes stocks of many different sized companies and is weighted, with those of larger market capitalization being given more influence on the index's result. S&P also has an index exclusively for small cap equities, the S&P 600. The Russell 2000 is also a weighted index and includes stocks with many different characterizations. The S&P 600, on the other hand, is a much more exclusive club. Entry into the S&P 600 requires undergoing a bit of looking under the hood, as it were. The individual equities are examined to be sure the companies have some standards to meet. In addition to meeting the definition for a small cap, firms must meet certain criteria such as, having a U.S. headquarters,  financial viability and liquidity. The S&P 600 index has actually outperformed the Russell 2000 index by 2% over the last 5 years. Return for the past five years (2001-2005) has averaged about 11% annually, where the Russell 2000 has averaged 8.99%. This is most likely due to it's makeup of stronger companies, due to the more difficult inclusion requirements.

Two widely tracked subsets of the Russell 2000 are the Russell 2000 Growth and the Russell 2000 Value indexes. Growth stocks are those whose earnings growth are expected to exceed the market average earnings growth. Value stocks are those that investors feel offer basically a good deal, based upon their fundamentals such as P/E ratio, dividend yield, net income and outstanding debt. If the stock  has a low price compared to others with similar statistics, it is considered undervalued relative to the market, and termed a “value stock”.

There are many examples of successful investors following both value and growth strategies. If one looks at the performance of the market indexes over the past decade, there are definite differences, and some interesting trends emerge. For the period of 1996 – 2005 we saw both ravenous growth and some precipitous declines. The declines gave more than a few people some sleepless nights, especially in the small cap sector, where more of the stocks were of the variety affected by the Internet bubble.

For the 1996-2005 decade, the Russell 2000 value index gained an average of approximately 14.3% annually. While impressive, it is all the more so, considering there were some frightening periods included in that decade. For example, for the 1998 – 99 time period, the index declined an average of about 4% per year, and, in case that didn't get your attention, it stripped over 11% from your investment accounts in 2002.

For the same time interval, the Russell 2000 Growth index returned an annual average of just under 7.4%. In addition to the growth index's lower average return, it was much more volatile. On a list of 8 key indexes of both large and small cap stocks, the 2000 Growth gave the best annual rate of return for two of the 10 years and the worst for 2 others. It gave the highest percentage increase of all the indexes tracked for the decade, 48.54%, in 2003. It would have a taken a year like that, however, to bring you back from the brink if you were in that index, as the previous year it fell over 30%, lowest of all the tracked indices for the decade.

The Value index, however, was no stranger to volatility, snagging the highest return for the 8 indexes three of the ten years, but chipping in two of the lowest annual return figures as well. Interestingly, in 1999, a year that the Russell 2000 Growth Index posted the year's best return numbers, 43.09%, the Value Index took the honors(?) for the lowest, at loss of 1.49%. The following year, the indexes swapped positions, with the 2000 Value returning the highest rate of the indexes tracked, at 22.83%, while the 2000 Growth slinked off with a -22.43% showing. In 2001, the 2000 Value was also the first place finisher, while the 2000 Growth still lost impressive numbers, -9.23%. That year was not pretty, however, and other indices lost considerably more, sparing the 2000 Growth Index from finishing in the cellar.

What does this mean for you? Well, in my opinion (opinion only, I'm not a financial adviser ) you can't go wrong with strong fundamentals. It's true for sports, and it's true for equities as well. Couple that with something that's always attractive, a low price relative to what other's are charging for something similar, and you've got a potential winner. If you're of a mind to try and pick individual stocks, look for those value oriented stocks in industries with solid future potential.