Friday, March 22, 2019

Value v/s Growth Investing

In the business world, the rearview mirror is always clearer than the windshield.

Warren Buffett
Successful stock market investors are often bracketed in one of two categories depending on their investment style i.e. Value Investor or Growth Investor. Both these styles can generate handsome returns for investors, yet they take diametrically different approaches to stock picking. Knowing the difference between these two styles is important in building an investment strategy and a diversified portfolio. So let us first understand the key differences between these two highly popular styles of investing, which I have tabulated below for ease of understanding

Distressed companies
Companies with growth potential
Type of Company
Well established
Buy low, sell high
Buy high, sell higher
P/E ratio
Investing basis
Ratio of current share price to intrinsic value
Inter-firm and industry-firm comparisons
Wrongly assessed value
Wrongly projected earnings
Tendency to outperform
During high GDP Growth and high inflation periods
During low GDP Growth and low inflation periods
Entry pricing
Fair to overvalued
Less volatile than the broader market
More volatile than the broader market

Value investing is about finding diamonds in the rough. Value investors seek to invest in businesses that are trading at a price much lower than their intrinsic value. Hence such shares are available at a bargain. They bet that markets will discover the correct value of such shares over a period of time and the price will rise. The businesses underlying such stocks are established businesses with strong cash flows and a history of consistent dividend payouts. Hence even when the price of such stocks is not appreciating much, dividend distribution may still satisfy investor’s return appetite for a while. Such stocks can become undervalued for many reasons, such as if a promoter of the company is involved in a personal scandal or if the company is caught doing something unethical. Stocks markets generally punish the occurrence of such incidents by pushing down the stock price steeply. At this point value investors step in, betting that such incidents will soon fade from public memory and the stock price will be restored to its original value. Legends of investing including Benjamin Graham and his disciple Warren Buffett, have long championed the cause of value investing

Growth investors on the other hand seek to find stocks that have the potential to outperform either the overall markets or a specific sub-segment of the market for a period of time. Growth stocks are associated with high-quality businesses whose earnings are expected to continue growing at an above-average rate relative to the market. Such stocks are generally costlier compared to their intrinsic value, but investor expectations of continued growth keeps pushing their price even higher. Such businesses often re-invest their earnings into their own growth and hence do not generally pay dividends. Investors therefore look for capital appreciation in such stocks as the only means to justify their investing decision.

Which style is better?
The answer to this question depends on the investor’s own risk profile, investing time horizon and current state of the economy. Conservative to low risk investors will prefer value stocks over growth stocks. Passive investors with a long time horizon will also prefer value stocks over growth stocks. If the economy is growing steadily then value stocks may do better than growth stocks. On the contrary, investors with moderate to high risk profile will find resonance with growth stocks. Active investors with a short to medium term time horizon will find growth stocks attractive. Finally growth stocks will certainly find more favor with investors when the economic growth itself is low.

What to Do?
First of all assess and understand your own risk profile. This will give you a good idea of how you should be investing the stock markets. Secondly assess the current economic climate on just two parameters – GDP growth rate and inflation rate. This will tell you what type of stocks to invest in. As you do this keep in mind that it is difficult to determine exactly when economic shifts will occur. Therefore if you want to err on the side of profits, you should combine elements of both value and growth investing with occasional rebalancing of your portfolio. This approach will allow you to benefit from each strategy regardless of the prevailing economic climate. This is also the approach that we follow when we pick stocks for our Client’s portfolio using our icAdvisor service. Do browse the stocks from the icTracker database that are used for delivering this service and feel free to revert with queries, if any.

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