What’s the Difference Between Growth and Value Investors?

I was talking to an investment club partner a few months back about different stocks and it occurred to me half way though the conversation that we were attempting to get to the same place (i.e. a profitable investment) but taking two completely different routes.  I forget the particular investment we were talking about but I had offered it up and his argument that this particular equity was not going to suddenly and dramatically increase earnings, while I was arguing that the metrics made it look like a good buy.

It wasn’t until my a-ha moment in the conversation that I realized why the conversation was going in circles.

What is a Growth Investor? How is that Different than a Value Investor?

According to investopedia a Growth Investor,

seeks out stocks with what they deem good growth potential. In most cases a growth stock is defined as a company whose earnings are expected to grow at an above-average rate compared to its industry or the overall market.

While a Value Investor,

seek[s] stocks of companies that they believe the market has undervalued. They believe the market overreacts to good and bad news, resulting in stock price movements that do not correspond with the company’s long-term fundamentals. The result is an opportunity for value investors to profit by buying when the price is deflated.

Typically, value investors select stocks with lower-than-average price-to-book or price-to-earnings ratios and/or high dividend yields.

Sounds like my buddy and I, huh?  I am not sure why (nature vs nurture) but he was acting as a growth investor at that moment while I was acting like a value investor.  I say “acting like” because like most things in life you shouldn’t just be on the extreme.

Are Growth Investors and Value Investors Really that Different?

As I have mentioned I am in the middle of reading Warren Buffett’s Berkshire Hathaway Annual letters (every so often outlining Buffett lessons and tidbits I find interesting) and while I haven’t outlined it yet he said something very interesting in his 1992 letter regarding the subject of value investing vs growth investing,

But how, you will ask, does one decide what’s “attractive”? In answering this question, most analysts feel they must choose between two approaches customarily thought to be in opposition: “value” and “growth.” Indeed, many investment professionals see any mixing of the two terms as a form of intellectual cross-dressing.

We view that as fuzzy thinking (in which, it must be confessed, I myself engaged some years ago). 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.

In addition, we think the very term “value investing” is redundant. What is “investing” if it is not the act of seeking value at least sufficient to justify the amount paid? Consciously paying more for a stock than its calculated value – in the hope that it can soon be sold for a still-higher price – should be labeled speculation (which is neither illegal, immoral nor – in our view – financially fattening).

Whether appropriate or not, the term “value investing” is widely used. Typically, it connotes the purchase of stocks having attributes such as a low ratio of price to book value, a low price-earnings ratio, or a high dividend yield. Unfortunately, such characteristics, even if they appear in combination, are far from determinative as to whether an investor is indeed buying something for what it is worth and is therefore truly operating on the principle of obtaining value in his investments. Correspondingly, opposite characteristics – a high ratio of price to book value, a high price-earnings ratio, and a low dividend yield – are in no way inconsistent with a “value” purchase.

Similarly, business growth, per se, tells us little about value. It’s true that growth often has a positive impact on value, sometimes one of spectacular proportions. But such an effect is far from certain. For example, investors have regularly poured money into the domestic airline business to finance profitless (or worse) growth. For these investors, it would have been far better if Orville had failed to get off the ground at Kitty Hawk: The more the industry has grown, the worse the disaster for owners.

Growth benefits investors only when the business in point can invest at incremental returns that are enticing – in other words, only when each dollar used to finance the growth creates over a dollar of long-term market value. In the case of a low-return business requiring incremental funds, growth hurts the investor

As with most things Buffett says it best! Like in life, it seems, that if you keep a strict dichotomy you are only hurting yourself.

 

Do you consider yourself a value or growth investor? Do you take a Buffett approach and try to met somewhere in the middle?

 

5 Responses to What’s the Difference Between Growth and Value Investors?

  1. This is basically what I always say, a pure value investor is simply just an investor. Any investment done without seeking a margin of safety from the fair value of the asset is speculation. Thanks for the article and clearing it up for everyone. I will be sharing, more people need to see this.

  2. This line resonates well with me and hits the nail on the head – of course Buffett says it best :)
    “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.”

    I consider myself a value investor, but growth always needs to be a component in it, as without any growth in revenues, earnings – your company will remain stagnant and will eventually have an enormous impact on future dividends and/or prices.

    Great post, MJTM.

    regards
    R2R

    • For my very mature dividend payers I don’t really consider growth as it seems to be built into their models. For example, WMT will have growth but not the type something like TSLA will have.

  3. I’ve been thinking about this a lot.

    I think growth and value are two separate variables, and they combine to impact the price. So like Buffett says it is both.

    However, in analyzing my own investing decisions, I’ve invested in value stocks that I didn’t believe would grow… and have done well on those investments. For example, I bought HP some 12 or 18 months ago when it was hit hard and had a PE of 4. They had no mobile strategy. They were rumored to be exploring selling off their computer division. Their printer and ink business have been declining with the growth of tablets. The company was a mess with failed Palm and Autonomy acquisitions.

    I jumped into something that I believed wouldn’t grow, because of the overwhelming value and the overwhelming negative sentiment against it. So it is possible to have a 100% value and 0% growth play.

    On a different axis of the grid, I bought into Facebook at around $22 believing that the sentiment was also vastly negative making it a good value. However, in this case, I believed it to have great growth potential. In this case, I believed it was both a significant value and had great growth potential.

    My only regret in these two stocks is that I sold them too early and gained “only” about 100%, when they’ve continued to go up significantly further.

    One can imagine a stock (perhaps Amazon this past January) that represents almost no “value” (it had run up significantly), but great growth potential. While someone might say that the “value” is in that growth potential, I couldn’t hop on board because it looked like people were far too bullish on it… almost like its own little stock bubble.

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