BackDifference between value investing and growth investing
Value investors will look for stocks that are trading at a price below their fundamental value
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If you speak to fund managers, many are of the opinion that stock picking is both an art and science. While that may be true, often fund management styles are bracketed into defined spaces. The most common being growth style of investing and value-based investing. While both these approaches require a fund manager to have an instinctively good stock picking capability, they differ in their approach.
Growth Investing
This approach focuses on the earnings capability of the company without being overly concerned about the current market price of the stock. The current market price of a stock other than just its absolute value suggests the worth of a company per unit of its earnings. This is technically referred to as the price-earnings (P-E) multiple. Typically a stock with a very high P-E can be risky for investment as the probability of a deeper downside is high. For growth investors, the P-E itself is not of much consequence. If earnings growth is keeping pace with the high P-E then they are happy to include stocks in the portfolio. Hence, if you follow this approach, you may end up buying stocks that are trading at a price higher than the fundamental value. The conviction is that this fundamental value will keep pace with the increase in stock price. These could be stocks of companies that are in early stages of growth or have a competitive advantage in terms of products or geographies. Such companies could also belong to a new industry. For example, in the late 1990s, information technology (IT) was a high growth industry and stock multiples ran far ahead of fundamentals. The lesson learnt from the IT growth stocks experience is that one shouldn’t get carried away by growth potential.
Every company is unique and you have to keep reassessing the company’s potential to deliver high growth consistently. These stocks tend to trade at a very high multiple, so a small slip up in earnings can lead to a big correction in the stock.
Value Investing
Value investors will look for stocks that are trading at a price below their fundamental value. Such stocks may belong to companies that are strong financially but are going through a bad business cycle. A company’s strength may get reflected in its balance sheet, low debt, high cash flow or even in the quality of management. However, because of market sentiment or just lack of awareness, this doesn’t always get translated into increase in stock prices. Value investment takes advantage of this mismatch in intrinsic value and market price.
You have to be careful, though, about how you evaluate the intrinsic value. Make sure that the lack of interest in a stock is not because of some fundamental flaw in the company.
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