Style index

Many portfolio managers describe themselves by style: "value fund manager" or "growth fund manager". Judging a value manager against the whole market is unfair in both directions — the style can lag or lead the market for years. So index providers built style indices, one for value stocks and one for growth stocks, to benchmark such portfolios fairly.

The workbook's popular sorting rule uses three ratios:

The styles can be crossed with company size to make six segments: large cap value, large cap growth, mid cap value, mid cap growth, small cap value and small cap growth — useful for managers following capitalisation-based styles.

Two ways of reading the same ratio. The workbook explains the styles through P/E = price per share ÷ earnings per share.

• A growth investor focuses on the denominator — earnings. They look for companies expected to show rapid EPS growth and implicitly assume the P/E stays roughly constant, so the price rises as earnings are realised. The focus is the company's economic "story", with less regard to valuation.
• A value investor focuses on the numerator — price. They believe the stock is cheap by some comparison, are not concerned with current earnings or their drivers, and implicitly assume the P/E is below normal and the market will "correct" it by raising the price with little change in earnings.

Turnover. Style indices generally have much higher turnover than broad market indices. Valuation ratios change over time, so stocks frequently migrate from one style category to another on reconstitution dates — and a manager must rebalance to stay true to the philosophy.

Where it sits. Section 8.5 groups stock market indices into broad market, market-capitalisation based, style and sectoral indices. Broad indices represent an entire segment; sectoral indices track sectors such as IT, banking, FMCG or pharma; style indices cut across sectors by valuation.

Company figures are illustrative.

Two stocks, and how each style expects to make money on them.

Growth stock G — EPS Rs 20, price Rs 900, so P/E is 45. P/B is high; dividend yield is under 1%.

Growth thesis: EPS grows 25% to Rs 25; P/E stays at 45
New price = 45 × Rs 25 = Rs 1,125   → +25%

Value stock V — EPS Rs 50, price Rs 400, so P/E is 8. P/B is low; dividend yield is high.

Value thesis: EPS stays at Rs 50; P/E re-rates from 8 to 12
New price = 12 × Rs 50 = Rs 600   → +50%

A manager with Rs 5 crore in each style gets returns from completely different sources: one from earnings, one from the multiple.

Why turnover is high. Suppose V re-rates as hoped. At P/E 12 with a falling dividend yield, it may no longer screen as value at the next reconstitution and migrates out of the value index — so the value index sells it just after it worked, and a value fund benchmarked to it has to follow. In a broad market index, V would simply have stayed in with a larger weight.

Chapter 8, section 8.5.3 (Style Indices), gives the P/E, P/B and dividend-yield classification, the numerator-versus-denominator reasoning and the turnover point; section 8.5.4 combines style with capitalisation. Chapter 8 carries 4% weight. Expect "which of these characterises a value stock" and "why do style indices have higher turnover than broad indices".

• Value = low P/E, low P/B, high dividend yield. Growth is the reverse. Examiners love to swap one of the three.
• Growth managers focus on the denominator (earnings); value managers on the numerator (price).
• Style indices have higher turnover than broad market indices, because stocks migrate between style categories as valuations change.
• A style index is not a sectoral index. Value and growth stocks come from every sector.
• Six cap-style segments: large, mid and small, each split into value and growth.
• The value investor assumes the P/E will normalise, not that earnings will jump.