Growth VS Value Investing

Growth and Value investing are two different investing styles.

Growth stocks represent companies that have demonstrated higher than average returns in earnings and profits. It is all about finding the next big thing, such as a ground-breaking technology that could potentially dominate the market. These are smaller & younger companies that are usually growing at a faster rate than the market. They tend to be within the growth stage of a business life cycle.

Value investing however, doesn’t look for companies that promise to change the world. Value stocks are stocks that have fallen below its intrinsic value, presenting an opportunity to enter a position. They are usually bigger companies at the maturity stage, where cash flows are relatively stagnant.

(Photo credits: Corporate Finance Institute)

Growth Stocks

Growth stocks are companies whose earnings are expected to grow at an above-average rate relative to the market. Growth companies typically have a competitive advantage that justifies their potential to dominate the market. Most of these stocks tend to be newer and younger companies that introduces some innovative product or technology that plays a significant impact on society.

Characteristics of growth stocks:

1. Zero dividends

A company that is growing at a rapid rate will typically choose not to pay dividends as it wants to reinvest its profits into future expansion. By investing into these companies, investors stand to benefit from capital appreciation instead of dividend income. Fun fact: Amazon and Google have never paid dividends to their shareholders!

2. Higher P/E ratio

A growth stock usually comes with a higher-than-average price-to-earnings ratio (P/E), which measures the price of a company's stock relative to its earnings per share. Higher P/E ratios indicate more expensive stocks, yet many investors are willing to pay this premium as it is bought on the promise of future exceptional growth.

3. Strong competitive advantage

The high growth rate that these companies experience is largely attributed to the competitive advantage they have over their competitors in the industry. With this competitive edge, it allows them to sell and grow faster.

4. Loyal customer base

With a competitive advantage over their competitors, they tend to enjoy a loyal and growing customer base.

5. Higher volatility

Growth stocks have historically exhibit a higher volatility than value stocks. The Beta value measures a stock's volatility compared with the overall market's volatility. For example, Amazon’s beta value relative to the market is 1.20, while Apple’s beta value is 1.28. This indicates that these stocks experience more price swings than the market, having more potential losses or gains.

Value Stocks

Value stocks are the opposite of growth stocks. A value stock is created when the shares are trading below the company’s intrinsic price. This typically happens when the company had temporarily fell out of favour in the market, triggering an exaggerated reaction from investors. A few common reasons for that includes disappointing earnings, negative publicity, or a change in major positions.

In 2016, when Howard Schultz was to step down from his role as executive chairman of Starbucks, the announcement shocked investors and caused the SBUX stock to tumble more than 10%. Its share price has since recovered.

Investors who entered a position then would have made sizable returns when the share price returns to its intrinsic value.

However, it may take a long time for value stocks to surface as it’s not typical that a company frequently falls out of the market. A lot of investors may also fall victim to the value trap, where they focus too much on buying cheap stocks and end up buying companies with weak fundamentals, where its stock price only gets cheaper.

Since both investing styles present different opportunities and drawbacks, which is the superior approach?

The answer to this depends on the investor’s risk appetite and the period in which the approach is used.

Risk appetite

An investor with a smaller risk appetite might choose to invest in value stocks, as investments in growth stocks can be risky. Because growth stocks do not offer dividends, the only opportunity to earn is through capital appreciation when an investor eventually sell their shares. If the company does not do well, investors take a loss on the stock when it's time to sell. They lose out on the dividends they would've otherwise gain if they invested into value stocks.

Historical data

According to the Bank of America, value stocks outperformed growth stocks over a period of 90 years starting from 1926 till 2016, earning 17% per annum compared to growth stocks’ 12.6%.

However, the near century-long trend of value investing outperforming growth investing has been broken since 2007, according to Bank of America.

(Photo credits: BofA US Equity & Quant Strategy)

For some, this signals that value investing is dead. For others, it’s a sign that the market has become too opportunistic and the reversal might be coming.

While you might be thinking, which investing style will suit me more? Fear not!

There are many hybrid approaches out there that combines both of these investing styles. Many investors hold both growth and value stocks in their portfolios to diversify their positions.

Introducing… GARP – Growth at a Reasonable Price

(Photo credits: Screenshot taken from SPGlobal)

GARP is a fundamental-driven investment strategy that balances pure growth and pure valuation. It invests into growth companies with solid fundamentals that are not too overpriced.

S&P has created the S&P 500 GARP index, an index that tracks companies with consistent earnings and sales growth, reasonable valuation, and solid financial strength, combined with strong profitability (SPGlobal, 2019). It comprises of 75 securities listed in the S&P 500 index and is identified to have the highest “growth scores” and “quality and value composite scores”.

While many of us like to identify ourselves as being either a growth or value investor, the truth is we’re all just looking for a solid company to put our monies in.

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