By: Phil Kernen

The use of investment indexes has grown significantly over the last few decades, with individual investors and portfolio managers using them as tools to measure investment returns. Most of the biggest index owners have created indexes designed to carve up the market between the best-known styles – growth and value stocks, terms frequently referred to explain market behavior. But the rules for dividing markets into these two styles are anything but consistent. 

Broad market indexes have been around for a while, but the idea of style indexes is relatively recent. Consider one organization that already offered a wide array of broad market indexes and subsets based on company size. It recognized that some investment managers focused on identifying companies they believed would grow rapidly and generate above-average returns. Other managers focused on finding companies that appeared undervalued relative to their long-term fundamental prospects. In response, it began breaking their various subsets into style indexes – value and growth.

The original methodology was straightforward, assigning companies entirely to growth or value indexes based on a single ratio, book-to-price, reflecting famed investor Benjamin Graham’s traditional approach to discovering undervalued companies. It classified companies above a midpoint as growth stocks and those below as value stocks. Subsequent research found that investment managers didn’t view every company as exclusively growth or value, holding many stocks in both styles in a single portfolio. 

From 1995 on, the organization assigned each company a growth or value weight based on several subjective metrics to determine expected growth values and ranked them. Companies that hovered around 50% for each were assigned to both indexes proportionally. Companies around the midpoint reflect proportionally weighted placements in both indexes. It may seem strange to discover companies that are part of both growth and value indexes, but this is why. Overall, 70% of names reside in either growth or value, and 30% reside in both. 

Every fourth Friday in June, the style indexes are reconstituted to reflect changes that occurred over the prior year. The shifting weights can often make this one of the highest-volume trading dates as investors tracking the indexes race to conform. Following the recent 2022 rebalance, well-known names whose presence in the growth index will dwindle as their presence in the value index becomes more pronounced include Netflix, Paypal Holdings, and Meta Platforms, which now holds the 6th largest weight in the value index. Gamestop will make the same trip and exit the growth index entirely. Procter & Gamble is the only company that resides in the top 25 of each style index – 21st heaviest weighted in growth and 10th in value.

A different index provider started with a similarly simple approach, splitting the market into growth and value solely based on price-to-book ratios. In response to competitors, it too adopted more complicated methodologies constructed using a variety of subjective growth and value factors. Allocations between value and growth differ slightly: 33% of stocks will rank exclusively in either the growth or value baskets, while 34% will rank in both. But because of the subjective nature and weights of the factors used, these indexes show more overlap at the top with different players: UnitedHealth, JPMorgan Chase, Pfizer, Visa, and Mastercard are all weighted in the top 25 of both.

Whether you use style indexes like growth and value as tools to measure investment returns or guidelines for investment, the subjectivity embedded in the rules to split the market means that no two are exactly alike. Keep that in mind the next time someone tells you indexes are all the same.