How to compose a Blend of Value and Growth Stock Portfolio 

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How to compose a Blend of Value and Growth Stock Portfolio

Instead of concentrating on only one style of investing, investors can choose a blend of value and growth stocks for their portfolios. Within this blend, there may be a bias toward one or the other style or a straight 50 percent allocation to each style. Generally, it is one style that tends to outperform the other style at a single point in time, so by investing in a blend of growth and value stocks, investors can benefit from the winning style. Another advantage of a blend is that investors avoid the question of when to pick the top of the winning style and when to enter the style that is expected to increase. The blend strategy of having exposure to both growth and value stocks lowers volatility risk.

The divergences in returns of the different styles of investing over time suggest that for buy-and-hold investors, who are not willing to time the different sectors, a blended portfolio of value and growth stocks spread among the different stock size categories is the answer. As market conditions change, the leaders in the stock markets eventually become the laggards, and then, over time, this process reverses. By diversifying into the different sectors of the market, investors avoid timing and market performance decisions. By going for a blend of stocks from value and growth styles, investors may be sacrificing on short-term performance, but they reduce their risk of having all their stocks invested in one equity style. For example, when interest rates go up, this has a more devastating effect on growth stocks than on value stocks. The reason is because growth stocks have higher P/E ratios, and with their high expectations, they are punished more severely than value stocks with their low P/E multiples and low expectations.

For example, by investing in an underperforming sector such as growth stocks, investors are taking advantage of the disparity in the markets to create opportunities. Examining what has happened in the market is a case in point. Value stocks have risen in the years after the Internet bubble, and many value stocks are no longer undervalued. This does not mean that investors should change their portfolios whenever there is some economic news. By broadening ownership into stocks that have not contributed to the rise in performance, investors can seek a balance between the leader and laggard stocks in the market.

Table 13–5 lists some value and growth stocks. The stocks were selected based on growth with a bias toward value. Growth stocks selected had either one-year growth rates in sales or earnings of greater than 14 percent. Because growth stocks have been the laggard style, the time horizon for growth in sales and earnings was reduced from three years to one year. The value stocks selected had P/E ratios of less than 12 and the potential to grow their future sales and earnings.

Reasons for Selecting These Stocks
In this blended portfolio of value and growth stocks, the emphasis was on finding stocks that were priced like value stocks but that also had greater growth rates. Stocks were screened, and only stocks that had P/E ratios of less than their growth rates were chosen. Cisco Systems was a borderline example, and Amgen an exception. Cisco Systems expanded its business operations through increased market share in the communications network and information technology sectors in addition to acquiring key companies to make the company more competitive. Cisco Systems seems to be a turnaround story after the technology slump in 2000, judging from its one-year growth in sales and earnings. Amgen, a leading biotechnology company, has a stream of successful products (Epogen, Aranesp, Neulasta, Neupogen, and Embrel) on the market, along with a number of promising drugs in the pipeline. Amgen had a disappointing year through November 2006 in terms of sales growth and a decrease in income. However, Amgen’s profit margins are higher than those in the industry, and it has the potential to increase its future sales and earnings growth. Oracle acquired four business software companies in 2006, which puts Oracle in a position to expand its market share in its industry.

Table 13-5
Portfolio of a Blend of Growth and Value Stocks

Portfolio of a Blend of Growth and Value Stocks

The last three stocks in Table 13–5 are value stocks. D. R. Horton is a home-building company in the United States. Stocks of homebuilding companies are cyclical and decline in price when the Federal Reserve raises interest rates. As of November 2006, these stock prices have plummeted from their record highs owing also to fears of an economic slowdown. A patient investor willing to wait out the three- to five-year cycle for these stocks to rebound would find value in the home-building stocks, particularly the larger companies that pay dividends. Citicorp is a diversified financial services company that is growing globally. With close to a 4 percent dividend yield and trading at 12 times trailing earnings, there seems to be little risk of loss for shareholders purchasing the stock. ExxonMobil is a well-run integrated oil company that continues to grow in all types of economic climates. Historically, ExxonMobil managed to expand its earnings despite the price of oil. When oil was trading in the low double digits over a decade ago, ExxonMobil increased its earnings by trimming expenses and continued its profitable trend when oil went up in price in later years. Shareholders have benefited because ExxonMobil has consistently raised its dividends, making it a relatively profitable investment.

Avery different portfolio also could be assembled with different interpretations of value and growth definitions. Fifty percent of this portfolio is in low P/E ratio value stocks that have good earnings expectations in the future and the balance of the portfolio put into stocks that are the leaders in their fields and have experienced exceptional growth despite their high P/E multiples.

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