What it means
S&P splits its major indices into growth and value segments, so that investors can follow each investing style separately. A growth company is one that is expected to expand its earnings and sales faster than the average company.
A value company is one whose shares look cheap relative to its earnings, assets or sales. To decide which group a company belongs to, the index methodology scores each stock on a set of growth measures and a set of value measures.
Growth measures include the pace at which earnings per share and sales per share have been increasing and how strongly the share price has risen. Companies with the highest growth scores are placed in the growth index.
Each company is usually assigned to only one style index or, if it falls in the middle, may be split between growth and value. The two indices together cover the whole parent index, so every company appears somewhere.
The weights depend on market value, so larger companies influence the results more. Growth stocks tend to be found in technology, healthcare and consumer industries where businesses reinvest heavily to expand.
They often pay low or no dividends because profits go back into the business. Their prices depend on future earnings, so they can fall sharply if growth slows or interest rates rise.
For finance professionals the S&P Growth indices are benchmarks. A growth fund manager is measured against them, and investors compare growth and value returns to see which style is in favour.
Leadership between the two styles often rotates over several years. Investors sometimes confuse style indices with sector indices.
A growth index is not a technology index, even though many technology firms sit in it, because the classification depends on the scores of each company rather than on its industry. A utility with strong growth could qualify, while a slow-growing software firm might not.
In practice
Real-world examples.
Example
A fund manager who specialises in fast-growing companies compares her fund against the S&P 500 Growth index. Her investors can see whether she adds value beyond the style itself.
Example
An adviser explains to a client why her portfolio has fallen more than the market in a year when interest rates rose. He shows that growth stocks, which depend on future earnings, were hit harder.
Example
A corporate pension committee splits a $30,000,000 equity allocation between a growth index fund and a value index fund. It aims to balance the two styles, and it reviews the split every year so that neither one drifts too far from the target.
Formula
Calculation
Index price return = (Ending index level - Starting index level) / Starting index level x 100.
Suppose a growth index starts the year at 4,000 and ends it at 4,600. The return is (4,600 - 4,000) / 4,000 = 600 / 4,000 = 0.15, or 15%. If a growth fund began the year at $200,000 and ended at $226,000, it returned $26,000 / $200,000 = 13%, which is 2 percentage points below the index. Over the same year, a fund that holds the same stocks as the index in the same proportions should match the index return before fees, and any gap shows the effect of stock selection, trading costs and charges.Case study
Seen in the real world.
Clearwater Partners is an entirely fictional wealth manager that tilted a client portfolio towards growth in a year of strong technology returns. In this illustrative story, the growth portion of the portfolio rose 22% while the value portion rose 6%.
The client, thrilled by the result, asked to move everything into growth. The adviser explained that style leadership changes and that a concentrated bet could hurt if growth stocks fell out of favour.
They agreed to a modest increase in the growth allocation from 40% to 50% and to review it each year. The illustrative lesson is that style indices are useful for measuring and balancing exposure, not for chasing last year's winner. Their written policy now states target ranges for growth and value, and any move outside the range triggers a review rather than an automatic trade.
Watch out
Common mistakes.
- Assuming growth stocks are always better than value stocks, when leadership rotates over time.
- Comparing a growth fund to the wrong index, such as a value index or a broad index.
- Thinking growth means safe, when high expectations can lead to large price falls if a company disappoints.
Questions
People also ask.
What makes a stock a growth stock?
Faster expected or past growth in earnings and sales than the average company.
Do growth indices include dividend payers?
Some members pay dividends, but many pay little because they reinvest profits.
Can a stock be in both growth and value indices?
Yes, some companies are split between the two so that every company is fully represented.
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