Han Dieperink: The dynamics between growth stocks and value stocks
This column was originally written in Dutch. This is an English translation.
By Han Dieperink, written in a personal capacity
Growth stocks have dominated the stock markets since 2017. Tech giants such as Apple, Microsoft, Amazon, Alphabet, Meta, Nvidia and Tesla have seen impressive share price increases. This reminds some of the dotcom era. This is not justified.
There is an important difference: the profit quality of these companies is now much better. Moreover, valuations are not yet at bubble level and value stocks lagged behind at the same time. Investors preferred to focus on exponential growth and technological revolutions. But this year we are seeing a turnaround. Value stocks are now outperforming growth stocks in the US and Europe. Only in China are growth stocks still on the rise. The question is: what is the potential of value stocks in this rotation? And when will growth stocks take the lead again?
The impact of interest rates
The standard explanation for the interest rate sensitivity of growth stocks is simple: growth companies derive their value from future earnings. When interest rates rise, these future cash flows are devalued more strongly. This hits growth shares harder. Value shares, with their emphasis on current income and dividends, are less vulnerable. Yet this does not explain everything. There are periods in which both interest rates and growth shares rise. The cause of interest rate movements is therefore crucial.
An often-forgotten factor is the competitive dynamic. Companies with high barriers to entry achieve returns that far exceed their cost of capital. Think of companies with strong network effects, technological advantages or powerful brands. When interest rates fall, their returns remain high, while the cost of capital falls. This leads to higher excess returns and justifies higher valuations. Companies in competitive sectors see their returns fluctuate in line with capital costs. When capital costs fall, new entrants are attracted. This causes price pressure, which reduces the increase in excess returns.
Sectoral differences
The sectoral composition reinforces this effect. Growth stocks are mainly found in technology and discretionary consumer goods. Intellectual property, network effects and economies of scale provide sustainable competitive advantages in these sectors. Value stocks dominate in sectors such as financial services, energy and basic materials. In the financial sector, regulations often create a direct link between returns and capital costs. For energy companies, the decision to invest is directly related to the capital costs versus expected returns.
In both cases, returns generally follow the cost of capital. IT represents more than 40% of the Russell 1000 Growth index. Financial stocks make up more than 20% of the Russell 1000 Value index. By choosing between growth and value, investors implicitly make a clear sectoral choice.
Market concentration
In recent years, concentration within growth indices has increased. Prior to 2017, it was value indices that were more concentrated. Value investors traditionally focus on large, stable companies. With the rise of tech giants, this has been completely reversed. The ‘Magnificent Seven’ (Apple, Microsoft, Amazon, Alphabet, Meta, Nvidia and Tesla) now represent an unprecedentedly high percentage of growth indices. This concentration confirms that growth stocks have benefited from higher barriers to entry. The increase in monopolistic market structures has led to more sustainable excess returns than was previously the case.
However, there are also risks. Regulatory attention for tech monopolies is increasing worldwide. The EU has passed the Digital Markets Act, China has already intervened with its technology giants and in the US support for stricter antitrust legislation is growing. If government intervention were to limit the excess returns of dominant tech companies, this would have a significant impact on growth indices.
Zombie companies
On the other side of the spectrum we find the zombie companies. These are companies that would not normally be viable, but continue to exist thanks to low interest rates over a long period of time. According to some definitions, these zombies make up 16% of listed companies in the US. They are characterised by low returns and minimal growth prospects – characteristics that are more common in value indices. A rise in interest rates could have a purifying effect on the value category. Weaker companies will disappear, improving the average quality of the remaining companies.
Growth versus uncertainty
Growth generally performs better during economic slowdowns or periods of uncertainty. Investors are then willing to pay a premium for companies that can deliver reliable growth, regardless of the broader economy. There are two important exceptions: the dot-com crash (2000-2001) and the tech-led profit recession of 2022. In both cases, value outperformed growth. This suggests that growth performs well in uncertain times, except when the uncertainty comes from the growth areas themselves. This also explains why Chinese growth stocks have recently performed well due to the rise of DeepSeek.
Conclusion
The fundamental qualities of growth stocks – reliable sales growth, high margins and sustainable competitive advantages – remain largely intact. Historically, market leadership rarely changes during a bull market. The expectation is that growth, led by IT and communication services, will regain the lead. Yet there are also opportunities for value investors. The current interest rate environment is more favourable for value stocks than it has been in the past decade, especially for financial institutions that benefit from higher interest margins.
Ultimately, growth and value are not opposing poles, but complementary investment styles. As Charlie Munger emphasised: most of the value is in growth companies. No share is so good that it cannot become a bad investment if it is too expensive. And few shares are so bad that they cannot be a good investment if they are cheap enough. It is all about balance: in the long term, value cannot be separated from growth, and growth ultimately creates value.