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?