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When you start investing in the market there are hundreds of strategies to consider. Each strategy has its own pros and cons list. The two strategies that are most often compared to each other are growth vs value investing. Each strategy has its place and time in your portfolio. Should they be used exclusively or in partnership? Today we will take a look at these two strategies to understand them better.
Growth stocks are securities that have had better than average gains in recent years. They also have an expectation of having a market advantage to continue this trend. Lately we have been seeing a high correlation to large tech companies being some of the largest growth securities. With their high-flying revenue lines, they have been leading the way in market gains. Tech stocks aren’t the only growth stocks, but they do all share a few characteristics.
High Earnings Growth: When we look at recent earnings reports of growth stocks, they traditionally have higher earnings reports and beats compared to their peers. This is often due to their increase in sales activity. It is also important to remember to look at both revenue and profit for growth companies. They are often reinvesting a significant amount of their profit to maintain their revenue growth.
Higher Price-To-Earnings: Growth stocks usually have higher price-to-earnings (P/E) ratios. This is due to their speculative nature. Investors are willing to pay a higher premium currently, in the anticipation that the security will have further appreciation.
Higher Volatility: The downside of growth stocks is their higher volatility. Growth stocks have high expectations when it comes to revenue. If there are stumbles for these companies, they often drop higher than other securities. This causes higher volatility for the stocks. With higher risk comes higher rewards.
Value investing on the other hand, looks at the underlying fundamentals of a stock. Using these fundamentals, (there are a variety of methods one can employ – including the Gordon Growth Model) investors can determine the ‘true’ value of the stock. If the security is trading at a discount to this value then it may be considered a value play. These value stocks also have a few key characteristics.
Lower Price than Sector: Value securities often are priced lower than comparable companies within their sector. This is often due to negative publicity or poor earnings reports suppressing the current price. When these events rise, value investors usually start new positions.
Priced by Current Fundamentals: The price of value stocks is often determined by current financials rather than future expectations. Value stocks often have relatively stable prices due to this. However, they can be significantly affected by changes to their current financial status.
Lower Risk: Since these stocks have usually been around a long time, they often carry lower risk. Their financials are relatively stable and reliable, thus creating a stable stock price. This can help reduce overall volatility of your portfolio.
Growth vs Value Investing
As you can see from the above chart, growth investing has outperformed value investing over the past 20 years. You can see this in particular in the FAANG stocks (Facebook, Amazon, Apple, Netflix, Google). All these stocks have had meteoric rises in recent years. This has really made growth indexes outperform the general market.
There are some strategies that value investing works better for. For example, if you are looking to generate reliable income through your portfolio then you may want to use value investing. These securities often have reliable dividends as well. Growth stocks on the other hand are reinvesting their capital in growing their stock.
Growth stocks are a lot like growing anything else. If you take a look Melanie’s 31st month of blogging you can see how exponential growth works for traffic and views. Growth investing works the same way. When you have stocks that are growing quicker you end up achieving your goals quicker. That is why growth investing is an important part of a portfolio especially early on.
As you get older and your portfolio grows, value investing becomes more important. Value investing tends to be less volatile and most investors prefer less volatility when they need to draw income from their stocks. Value investing also has the benefit of having income built into it with dividends that these portfolios provide. A strong dividend portfolio can create income for the owner while protecting capital to continue growing.
Value and Growth Investing: The Warren Buffett Strategy.
“In our opinion, the two approaches are joined at the hip: Growth is always a component in the calculation of value, constituting a variable whose importance can range from negligible to enormous and whose impact can be negative as well as positive.” – Warren Buffett
Most portfolios do not have a single strategy that they employ. That is where the combination of these two strategies come into play. When we use both of them together, we can create a more reliable and consistently growing portfolio.
Past performance is not indicative of future results however, we do have data on combining these two strategies. If we use the data that Gerstein Fisher Research put out, we can see that a combination of these two portfolios actually outperform either one left by themselves. This is important to note because this is exactly what Warren Buffett was referencing in his quote above.
Whether you would like to employ either strategy, it is important to remember that the market is a roller coaster. It is important to employ a strategy that fits your risk tolerance and overall objectives. As always time in the market beats timing the market every single time.
Hopefully by now you have a better understanding of the difference between growth vs value investing. These are two pillars of the investing world and terms that are often thrown around when analyzing individual stocks. There are both pros and cons to both strategies but they are strongest when they are deployed in conjunction with each other.
Do you use either of these strategies? Or do you have a preference of another strategy? Let us know in the comments below about your favorite strategies and experiences!
Will writes over at Millionaire Man Cave where he uses his knowledge of nearly a decade of retail banking and teaching financial literacy courses to improve other’s knowledge. He also writes about philosophy, behaviors and aesthetics to help others improve and become who they want to be. You can find him on Twitter @CaveMillionaire.