Growth Vs Value Investing: Which approach will work for you?

Welcome ladies and gentlemen. We are back again with another discussion growth Vs value investing

and admittedly it’s not as fierce as

the debate as active versus passive

but it’s an important one to understand

nonetheless, these are after all two of

the most popular

fundamental approaches to investing and

chances are you’re employing

one of them right now if you invest

actively through

a mutual fund or ETFs but while both

styles of investing belong to the same

school of thought

they employ polar opposite criteria for

selecting investments

so let’s go overgrowth in value

investing and how they square up

on today’s plain bagel

growth and value investing form a sort

of the dichotomy within the fundamental

school of investing

Growth Vs Value Investing

growth investing on the one hand is the

fast and furious approach

that has been particularly popular and

successful over the last few years

whereas value investing is the slow and

steady philosophy

made popular by Warren Buffett himself

the two approaches are broad and themselves can be further divided

into many different

strategies but you can generally

categorize stocks under one of these two

approaches based on three

characteristics

the first of which is the growth of the

underlying company

by growth here, we’re referring to how

quickly a company’s revenues

profits and or cash flows are increasing

on an annual basis

and when it comes to growth investing

this is the primary focus

naturally, you see growth investors are

trying to invest in those companies

that are growing faster than the market

in a bid to earn higher than average

returns

it’s about finding the next big thing

that new technology

app or groundbreaking product that’s

taking off and has the potential to

dominate the market

making it particularly attractive for

beginners who are trying their hand at

stock picking

generally, the investor will screen

companies that have experienced at least

a couple of years of rapid expansion

oftentimes anything above 20 percent

because of this requirement

these companies tend to be smaller and

younger

as it can be difficult to achieve these

higher growth rates when you’re already

larger or

more mature but this isn’t a requirement

for growth investing

these days there are some more

mature goliaths like Microsoft and

amazon

that continues to grow rapidly so it’s

common to find these two companies

labeled as growth investments despite

their huge size

now value investing on the other hand

doesn’t look for those flashy

companies that are breaking records or

promising to change the world

as a result, these investors are more

willing to put their money behind more

boring and stable companies that are

likely more mature

and in some cases may even be

experiencing the decline

this isn’t to say that value investors

don’t want growth in their positions

but it isn’t the primary criteria they

use to pick their stocks

that instead comes from our second

criteria the stock’s valuation

as the title implies value investing is

about being a bargain hunter

finding the diamond in the rough and

paying 95 cents on the dollar for your

position

the thinking is that stock prices often

deviate from their true worth or their

intrinsic value

so value investors will try to identify

stocks with solid fundamentals that are

currently selling for less than what

they should be

by finding and buying these companies

the investor will profit when the stock

price eventually corrects itself and

returns to its fair value

with the style, it’s common for investors

to focus on more mature companies that

are currently out of favor with the

market

because of some temporary headwind

although some value investors will put

money in declining

or even bankrupt companies if they

believe that they’ll get more money back

then what they put in through the

liquidation process

now there are many approaches for

determining the value of the intrinsic

worth of a stock

but an easy one for comparing value and

growth stocks are the P/E multiple

which divides the stock’s price by its

earnings per share

to show the investor how much they’re

paying per dollar of annual profit

there are other multiples you can use

here that might be more appropriate

including price to book value or ev2

EBITDA

but for simplicity’s sake, we’ll stick

with pe for this post

the P/E ratio shows how much an investor

is willing to pay

for stocks operations and by comparing

it to the multiple of peers and the

the market as a whole

investors can see which companies are

cheapest in their industry

for example, imagine a value investor

finds a bagel company

that’s trading at a P/E multiple of five

times compared to other bagel companies

which are trading at a P/E of 10 times

the company appears to be cheaper and

while the stock is currently out of

favor with the stock market

the investor carries out some research

and determines that the company has a

good management team

and strong fundamentals so with the

the belief that the company will eventually

return to a 10 times multiple

the investor will buy the stock knowing

that even if things stay flat they

aren’t paying too much for the stock

so there’s less at risk if things don’t

go the way they expect

now value investors don’t buy stocks

just because they’re cheap

they will carry out the fundamental

research to make sure that their

holdings will perform well over time

and in some cases, they might even

experience high growth but

the idea is to limit how much they’re

paying for these stocks

growth stocks on the other hand tend to

be more expensive and will often have

fairly high P/E ratios

it’s not uncommon to find these

companies trading at 30

40 times even 100 times their earnings

within the growth universe

sometimes the multiple doesn’t even

apply because they don’t have earnings

to back up their valuation

because these companies are reporting

higher than average growth though they

tend to draw a lot of investor demand

which is what leads to these higher

valuations a higher stock price compared

to lower profitability

now this can make it harder for the

investor to earn a return

because you are paying a premium for

these stocks you’ll need to earn

more to justify the investment but

growth investors will pay this price

if they believe the growth of the stock

is worth the price tag

for example, imagine a growth investor

finds a tech company that’s trading at a

P/E multiple of 30 times

while this multiple may seem expensive

the investor might buy the stock if they

see that the underlying company

is growing rapidly if the company

doubles its operations in a couple of

years

the stock won’t seem so expensive for

what the investor paid for it

so the growth of the underlying company

and the valuation of its stock are two

key characteristics

of value in growth investing and each

the style focuses on one of these two

characteristics

the final differentiating factor is the

stock’s volatility

or how much the stock’s price is

fluctuating now this isn’t something

investors are

inherently screening for when they’re

deciding which company to invest in

but because growth companies tend to be

younger firms with higher valuations

their stock prices tend to jump around

more than value stocks

which often are more stable so while a

growth stock may experience a stock

return of thirty percent one year

negative forty the next and then sixty

percent a value stock will often be a

quite a bit more boring

perhaps returning a consistent eight

percent a year

so those are the traits that

differentiate the types of stocks each

approach focuses on

and as you would imagine each style

exposes the investor to many

different

advantages and weaknesses for growth

investing

the main pro is the higher return

potential as you would probably expect

finding a company early on that

does go on to dominate the field

can make those involved fairly wealthy

the cons however are that this tends to

be a more risky approach

not only are these stocks more volatile

but growth stocks are often

bought and sold on the promise of future

exceptional growth

oftentimes without the history to

support it this is a problem when you

consider that investors are paying a

the premium for these stocks

if investors pay a 30 times multiple for

a company that’s been growing 40

a year and next year the company reports

a measly 5

growth the valuation has a long way to

fall if the market suddenly removes its

growth premium

you might hear for example that these

companies are priced for perfection

meaning that anything that falls short

of that can hit the stock price

when it comes to value investing the pro

is that it’s often the boring approach

meaning that it’s less volatile and less

risky typically a value investor will

put money behind more established

companies with a

longer track record of success which

reduces the likelihood of some drastic

change

impacting their stock price the cons are

that it can take a lot of time for the

value of a stock to surface

sure you might identify a stock that’s

undervalued but if it takes you 20 years

to see the value

redeem itself then it might not be a

good holding

on top of this value-investors can fall

victim to what’s known as the value trap

where they focus too heavily on buying

cheap stocks and end up with crappy

positions that are only getting cheaper

you see just because the stock is cheap

doesn’t mean that it’s a good buy

and there’s always a chance valuation

will fall further than what it currently

is

if the underlying business is

deteriorating sure you might find a

the company at five times multiple but

if it goes bankrupt it’s all for naught

as you can see

both styles present different

opportunities and drawbacks

but which one is the superior approach

well

the answer to that depends on when you

ask the question

according to a bank of America Merrill

lynch study value stocks outperformed

growth stocks over 90 years

starting in 1926

earning 17 percent annually compared to

a growth of 12.6 percent

however, growth stocks have taken the

crown over the past decade

having outperformed value stocks since

2007 by a fairly large margin

for some, this signals that value

investing is dead

for others, it’s but a sign that the

markets have become too optimistic

and that a reversal is just around the

corner regardless

you can see that value in growth

investing perform better during

different periods

with growth stocks often taking the lead

during extended bull markets

but here’s the thing while some people

might religiously follow the tenants of

the value investor or

lambast anyone who isn’t buying the

the latest and greatest stock

you can apply aspects of both styles

many people will hold both

growth and value positions in their

portfolio to diversify their positions

and there are hybrid strategies out

there as well Garp for example

stands for growth at a reasonable price

and it involves investing in growth

companies with solid fundamentals

Those aren’t too expensive so there are

some approach that kind of balance the

two

so while many of us like to identify as

being either growth or value investors

the truth is that we’re all just looking

for solid companies to put our money

behind

so there’s no need to compete besides

some of us are just better at investing

than others

and that’s nothing to be mad about what

what are my returns that’s

confidential information

you’ve probably heard before that many

of the most successful business people

and investors in the world are avid

readers Buffett himself is known to read

five to six hours a day

and as an analyst, I’ve always tried to

keep up but between the youtube channel

working in just

other life events I’ve fallen

behind on my reading list

especially on non-investment related topics

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Yadav Patle
Hello, I am Yadav Patle. Civil Engineer by education. Stock market investor. I can guide you to start investing in a very simple language. Want to know more click here.

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