Value vs growth investing: Which style is better for you?

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Equity investors often categorize stocks as either growth or value stocks. The growth vs value investing debate is decades old. Some investors prefer one style over the other. Both strategies aim to generate the best possible returns, but there are a number of differences between the two. In this value vs growth investing comparison, let’s check out how they differ and which style is better for you.

Value investing

Warren Buffett has been the biggest proponent of value investing. Value investors look for stocks that appear to be undervalued because they have temporarily fallen out of favor for some reason. The idea is to find stocks whose market value doesn’t reflect their fundamental worth. In time, the market will realize its true worth and the stock will appreciate.

Value investors don’t chase the high-flying blue-chip stocks because the price could be too high relative to its fundamentals and earnings growth potential.

Value stocks have strong fundamentals. The stock may have fallen sharply due to investors’ overreaction to negative events such as lower than expected earnings, legal troubles, regulatory hurdles, negative publicity, or macroeconomic conditions. Value investors’ thesis is that solid companies are capable of surviving the temporary setbacks and deliver good returns in the long run.

Some stocks look cheap but they don’t have strong fundamentals or trustworthy management. Their competitive advantage might be eroding or they are struggling to compete with newer, more innovative companies. They are called value traps, which should be avoided at all costs.

Most value stocks pay healthy dividends. So, investors stand to benefit not only from stock price appreciation but also from dividends. Historically, value stocks have done well during an economic recovery. But they tend to lag behind growth stocks in sustained bull markets.

Growth investing

Growth investors seek capital appreciation over the long-term when they pick a stock. They are interested in businesses that are growing faster than their peers and the broader market. Instead of distributing their earnings to shareholders in the form of dividends, growth-obsessed businesses reinvest it to drive future growth.

Growth-focused companies spend heavily on R&D, expansion, and new initiatives. It’s “Go big or go home” for them. Some of their initiatives may fail despite all their efforts. Growth companies offer significant upside potential, but they could be riskier bets.

Growth stocks often command a premium, trading at higher price-to-earnings and price-to-book ratios. Investors believe they will be able to sell the stock at an even higher price in the future as the company continues to grow. Some growth companies manage to achieve high earnings growth even in times of economic slowdown. But there is no guarantee that they will sustain the robust earnings growth.

Growth stocks tend to be highly volatile. They sometimes trade at lofty valuations, and the price could fall dramatically on any negative news.

Value vs growth investing: Which one suits you?

Both investing styles have their own set of benefits. The value vs growth investing debate has been going on for decades. Historically, value stocks have delivered excellent returns early in an economic recovery. But growth stocks have done well in sustained bull markets. Growth stocks also tend to perform better when interest rates are declining and corporate earnings are rising.

Growth investing is for people with appetite for high risk and high volatility. It’s for people with little interest in dividend income. Growth investing is suitable for those who have a knack for picking winners early and sitting tight through volatility until the company realizes its full potential.

Value stocks are far less expensive than growth stocks. And they are less risky because they have a proven and profitable business model. The stock may appreciate when other investors realize its real worth.

Even if the stock doesn’t appreciate as much as you expected, such companies distribute a large portion of their earnings among shareholders in the form of dividends or stock buybacks. Value stocks are for people who prefer lower volatility in stock prices.

Value vs growth investing: Do you really have to choose between the two?

Not necessarily. In fact, some stocks have both value and growth elements. One style does better than the other in certain economic environments, and vice-versa. As an investor, you can take advantage of both styles to generate high returns in the long-run. A portfolio consisting of both value and growth stocks will get the best of both worlds.

Billionaire investor Warren Buffett wrote in his 1992 letter to shareholders that most analysts and finance experts view the two investing styles – value and growth – as the opposites. Buffett believes the two styles are “joined at the hip.” Growth is always an important component when calculating value.

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Value Vs. Growth Investing: Understanding The Basic Differences

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Why understand investing styles?
With the wide variety of stocks in the market, figuring out which ones you want to invest in can be a daunting task. Many investors feel it’s useful to have a system for finding stocks that are worth buying, deciding what price to pay, and realizing when a stock should be sold.  Bull markets, periods in which prices as a group tend to rise, and bear markets, periods of declining prices, can lead investors to make irrational choices. Having objective criteria for buying and selling can help you avoid emotional decision-making.   We discuss the perils of emotional decision-making in many of our RGA monthly investment commentaries.   Even if you don’t want to select stocks yourself, it can be helpful to understand the strategies to which professionals adhere in evaluating and buying investments.  If you align with a given investment strategy, you may be better prepared to hire an investment manager who shares a similar investment philosophy.

There are generally two schools of thought about how to choose stocks that are worth investing in.  Value investors focus on buying stocks that appear to be bargains relative to the company’s intrinsic worth.  Growth investors prefer companies that are growing quickly, and are less concerned with undervalued companies than with finding companies and industries that have the greatest potential for appreciation in share price.  Either approach can help you better understand just what you’re buying—and why–when you choose a stock for your portfolio.

Value Stocks                                  
Relatively low P/E ratio
Low price-to-book ratio
Relatively slow earnings growth
High dividend yield
Sluggish sales growth
Growth Stocks
High P/E ratio
High price-to-book ratio
Rapid earnings growth
Low or no dividend yield
Rapid sales growth
Value investing
Value investors look for stocks with share prices that don’t fully reflect the value of the companies, and that are effectively trading at a discount to their true worth.A stock can have a low valuation for many reasons.  The company may be struggling with business challenges such as legal problems, management difficulties, or tough competition. It may be in an industry that is currently out of favor with investors. It may be having difficulty expanding. It may have fallen on hard times.  Or it may simply have been overlooked by other investors.

A value investor believes that eventually the share price will rise to reflect what he or she perceives as the stock’s fair value. Value investing takes into account a company’s prospects, but is equally focused on whether it’s a good buy. A stock’s price-earnings (P/E) ratio–its share price divided by its earnings per share–is of particular interest to a value investor, as are the price-to-sales ratio, the dividend yield, the price-to-book ratio, and the rate of sales growth.

Value-oriented data
Here are some of the questions a value investor might ask about a company:

  • What would the company be worth if all its assets were sold?
  • Does the company have hidden assets the market is ignoring?
  • What would the business be worth if another company acquired it?
  • Does the company have intangible assets, such as a high level of brand-name recognition, strong new management, or dominance in its industry?
  • Is the company on the verge of a turnaround?

A contrarian investor is perhaps the ultimate example of a value investor. Contrarians believe that the best way to invest is to buy when no one else wants to, or to focus on stocks or industries that are temporarily out of favor with the market.

The challenge for any value investor, of course, is figuring out how to tell the difference between a company that is undervalued and one whose stock price is low for good reason.   Value investors who do their own stock research comb the company’s financial reports, looking for clues about the company’s management, operations, products, and services.

At RGA Investment Advisors, we fit into the ‘value investor’ camp.  We seek investments with an identifiable margin of safety, a true underlying value, and a cost lower than the asset’s fundamental worth.   We use a metric of financial and performance screens to identify investment opportunities, and we follow a watch-list of competitive companies with long-lasting, measurable advantages.  We further perform comprehensive financial analysis paired with deep company diligence in order to develop the necessary conviction.  We only buy investments within an opportune price range, and we practice patience and diligence when making purchases in client accounts.  (Read more about our investment approach here).

Growth investing
A growth-oriented investor looks for companies that are expanding rapidly. Stocks of newer companies in emerging industries are often especially attractive to growth investors because of their greater potential for expansion and price appreciation despite the higher risks involved. A growth investor would give more weight to increases in a stock’s sales per share or earnings per share (EPS) than to its P/E ratio, which may be irrelevant for a company that has yet to produce any meaningful profits. However, some growth investors are more sensitive to a stock’s valuation and look for what’s called “Growth At a Reasonable Price” (GARP). A growth investor’s challenge is to avoid overpaying for a stock in anticipation of earnings that eventually prove disappointing.

Growth-oriented data

  • A growth investor might ask some of these questions about a stock:
  • Has the stock’s price been rising recently?
  • Is the stock reaching new highs?
  • Are sales and earnings per share accelerating from quarter to quarter and year to year?
  • Is the volume of trading in the stock rising or falling?
  • Is there a recent or impending announcement from or about the company that might generate investor interest?
  • Is the industry going up as a whole?

Momentum investing: 
A momentum investor looks not just for growth but for accelerating growth that is attracting a lot of investors and causing the share price to rise. Momentum investors believe you should buy a stock only when earnings growth is accelerating and the price is moving up. They often buy even when a stock is richly valued, assuming that the stock’s price will go even higher. If a stock falls, momentum theory suggests that you sell it quickly to prevent further losses, then buy more of what’s working.  The most extreme momentum investors are day traders, who may hold a stock for only a few minutes or hours then sell before the market closes that day.  Momentum investing obviously requires frequent monitoring of the fluctuations in each of your stock holdings, however. A momentum strategy is best suited to investors who are prepared to invest the time necessary to be aware of those price changes.

Please do not hesitate to let me know if you have any questions on this post or my own investment philosophy.

Best regards,

Jason M. Gilbert, CPA/PFS, CFF
T: 516-665-7800
E: [email protected]

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