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
