Value, growth, and quality as labels

In short

A friend of mine once asked me whether his fund was a value fund or a growth fund, and I had to admit the label did not tell either of us very much. You have probably seen these words on fund pages and wondered what they promise. Value, growth, and quality are labels that describe how a fund picks its stocks, not how it will behave next year. A fund company, an index provider, or a research firm hands out each label by a stated method, and the methods differ. Before you rely on a label, read the fund's own prospectus to see what the manager or index actually does. Two funds with the same label can hold very different stocks. Check what you really own.

The whole of it

What it is

I once watched a man at a county fair sort apples into bins, and he told me the sorting depended on what the buyer wanted. Stock labels work the same way. If you are holding a fund, or thinking about one, you have probably noticed these three words on the cover.

A value stock is one whose price looks low next to something measurable about the company, such as its profits or the book value of what it owns. Book value is the worth of a company's assets after its debts are taken out. A growth stock is one whose sales or profits have been rising fast, or are expected to, so its price often looks high next to those same measures. A quality stock is one with traits like steady profits, low debt, and strong returns on the money the business puts to work.

None of these words is a law of nature. They are sorting tools. The people who build a fund or an index pick the tool, and they can pick different ones. That is why a stock can be called value in one fund and growth in another.

How it works

A friend of mine who runs a small hardware store says you can judge a shop by its shelves, not its sign. The same goes here. The sign is the label. The shelves are the actual holdings.

An index provider such as MSCI, S&P Dow Jones Indices, or FTSE Russell writes a rulebook. The rulebook says how to score each stock on traits like price to earnings, price to book, sales growth, or debt level. Price to earnings is the share price divided by the profit per share. Price to book is the share price divided by the book value per share. The provider then puts stocks into groups based on those scores. A fund that tracks the index buys what the rulebook lists.

An actively managed fund works a little differently. A person or a team picks the stocks, and the fund's prospectus says in words what they look for. The label on the fund is their own summary of that approach.

Some stocks land in both camps. A company can look cheap and still be growing. Index providers handle this in different ways, and some split a stock between the two groups. Rules change, too. A provider may adjust its method, and a fund's holdings can shift when it does.

Fees come into this as well. A fund charges an expense ratio, which is the yearly cost taken out of the fund as a share of your money. The label does not tell you the cost. The fund's fee table does.

The numbers, and where to find yours

You do not need a special tool to check a label. You need the fund's own documents, and you are entitled to read them.

Start with the prospectus, which every U.S. fund must provide under rules enforced by the Securities and Exchange Commission. Its summary section describes the fund's strategy in plain terms. Look for the words the fund uses to define value, growth, or quality. Then find the fee table to see the expense ratio. The SEC's EDGAR database holds these filings, and the fund company's website carries the same papers.

Next, look at the holdings list, which the fund company posts on its site. Look at the top ten holdings and the sector mix. If a fund called value holds many of the same big names as a fund called growth, you have learned something the labels hid.

For index funds, the index provider publishes a methodology document. It spells out the scoring rules, and it is worth ten minutes of your time. Morningstar also publishes its own style grid, a nine box chart that places funds by size and by value or growth tilt. Its boxes come from Morningstar's method, not from the fund, so they can differ from what the fund says about itself.

A worked example

I once knew a retired teacher named Ruth who wanted to understand what she held. She had $20,000 in a fund called a large value fund. She also had $20,000 in a fund called a large growth fund, and she wondered if she had two real choices.

She opened each fund's holdings list. She found that her value fund held a bank, an oil company, and a drug maker among its top names. Her growth fund held two software firms and a chip maker. So far the labels fit.

Then she looked at the sector weights. The value fund had 24 percent in financial companies and 6 percent in technology. The growth fund had 4 percent in financial companies and 38 percent in technology. She added the two tech slices by their dollar amounts. Six percent of $20,000 is $1,200. Thirty eight percent of $20,000 is $7,600. Together that is $8,800 in technology out of her $40,000 total, or 22 percent.

That told her something no label had. Her two funds were quite different, but both still gave her a big slice of tech. She also compared fees. The value fund charged 0.40 percent a year, which is $80 on $20,000 (0.004 times $20,000). The growth fund charged 0.75 percent a year, which is $150 on $20,000 (0.0075 times $20,000). The gap was $70 a year, and she had never noticed it.

Ruth did not need a new fund. She needed to know what she owned and what it cost. Reading the documents gave her that in one afternoon.

Where it goes wrong

I have made this mistake myself, so I say it gently. It is easy to trust a word on a page. A label feels like a promise, and it is not one.

One trap is assuming the label predicts results. A value fund can lag for years, and a growth fund can too. Labels describe how stocks were picked, not what prices will do. Another trap is style drift. A manager may start a fund as value and later buy things that look more like growth. The prospectus may allow this, so the name on the cover can outlive the strategy underneath.

A third trap is treating all quality funds as the same. Quality has no single agreed meaning. One provider may score it by return on equity and low debt. Another may add earnings stability. Two funds with that word in the name can hold quite different stocks.

Overlap is a fourth trap, and Ruth ran into it. Owning a value fund and a growth fund does not guarantee you are spread out. Check the holdings and sector mix.

Last, cost can hide behind a friendly label. A fund with a fine sounding name can charge more than a plain one. Read the fee table.

Questions to answer before you leave this page

What does the prospectus of your fund say, in its own words, about how it picks stocks? Does the holdings list match the label on the cover, or does it surprise you? Which index or method sits behind the label, and have you read its rulebook? How do the sector weights of your funds compare, and do two of them lean on the same industry? What is the expense ratio of each fund, and what does that come to in dollars on the amount you hold? Has the fund changed its strategy or its index in recent years, and where would that be disclosed? And if you set the labels aside for a moment, could you describe in your own plain words what you own?