Growth, after long stalemate with value, may be evident

NEW YORK - Professional investors are always searching for clues about which segment of the market is poised to take off next, and right now, many are betting on growth stocks.

Value stocks had a distinct advantage earlier this year, as they often do in the first part of a recovery, when companies in the most economically sensitive industries - such as producers of cars, steel and housing - post the sharpest gains. But with the economy strengthening and the earnings of traditional value companies starting to flatten out, money managers are leaning toward growth.

"As you get later in the cycle, people begin to rotate and look for stocks that are likely to sustain an above-average growth rate going forward," said Greg Forsythe, a senior vice president of equity research at Charles Schwab Corp. "We think we're at that transition point."

To novice investors, the difference between growth and value stocks might not be obvious, but among financial professionals, few things inspire more passionate debate than which of these investing styles is a better long-term strategy.

Some money managers spend their whole careers investing in value stocks - those that are undervalued by fundamental measures, usually mature companies that have stopped growing and use their earnings to pay dividends.

In contrast, growth investors are focused on finding stocks with a high potential for robust earnings expansion in the future.

These are often in fast-moving parts of the market, like technology or pharmaceuticals, and may be more expensive and more volatile than value stocks.

For most small investors, a balanced, blended approach is best. It's worth knowing, however, that one style may have an advantage over the other at various points in the market.

Value beat growth by huge amounts in the period after the tech bubble burst. For about the last two years, they've been close to a stalemate.

Now there are signs that growth stocks are starting to eke out an edge.

The value stocks in the Russell 1000 index - a list of the 1,000 largest U.S. stocks - have seen a total return of 3.99 percent since the start of the year, compared to 3.08 percent for growth.

But so far this quarter, the Russell 1000 Value index is up only 0.94 percent, compared to a rise of 2.28 percent for Russell 1000 Growth.

Dave Hintz, a senior research analyst with the Russell Investment Group, has been watching the transition for a while. One of the first signals he noticed came about 18 months ago, when growth managers stopped falling behind value managers. But it's too soon to say they've pulled ahead, he said.

"This is what we've seen with this stalemate, it's going back and forth, so obviously the question out there is, is the second quarter the inflection point?" Hintz said.

"These things are always easier to identify 12 months later. At this point, it's one data point, so it's not clear if it's a trend."

A number of professional money managers think that it is, and they've been favoring high-quality growth stocks for a while, Hintz said.

For example, over the last 12 months, a growing number of value managers have bought Microsoft Corp., traditionally viewed as a growth company.

The fact that a large, stable company like Microsoft is still considered a growth stock in many quarters underscores an important point: While generally considered riskier than more conservative value stocks, some growth companies are safer than others.

If you're interested tilting your portfolio toward growth, there are a few things you should consider to minimize your risks, said Forsythe, of Schwab.

Look for stocks whose forecasted earnings growth over the next several years is well above market averages, Forsythe said. The average annual return for the Standard & Poor's 500 is 6 percent to 8 percent, so seek out companies expected to grow 12 percent to 15 percent. Avoid those with forecasted earnings higher than 25 percent, however, because that degree of growth is usually not sustainable.

Be cautious of stocks that have high growth expectations but haven't delivered on them, Forsythe said.

This sort of speculative growth stock differs from quality growth stocks that have reasonable expectations of growth and a track record of delivering better-than-average growth in the past.

"The most important characteristic in determining quality is historical growth stability," Forsythe said. "It has to have grown earnings, but also grown at a consistent rate."

It's also wise to take a close look at what analysts expect from the stock. Don't just look at the average estimate, check out the high and low estimates. If the numbers are close together, it means the analysts are largely in agreement about the stock's prospects. This is a good way to avoid controversial companies.

Larger companies, those with a market cap of $3 billion or higher, are more likely to be stable. Some of the growth companies that pass all these screens include 3M Co., McGraw Hill, Nike Inc. and Clorox Co.

"If you can avoid speculating on the next cure for cancer or whatever, you can do very well investing in growth stocks," Forsythe said.

"Leave out the ones that are relying on hype, and look for those that are providing growth in a stable manner. Those stocks are not that risky at all."