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27/10/2017

Growth vs. Value Investing

The argument over a growth-investing strategy versus a value-investing strategy is likely as old as the stock market itself. Let’s take a look at both strategies and see which is best used in which situation.

Growth Investing

Growth investors are attracted to companies that are expected to grow faster (either by revenues, cash flows, and definitely by profits by in the future) than the rest. As growth is the priority, companies reinvest earnings on themselves in order to expand, in the form of new workers, equipment, or acquisitions.

Don’t expect dividends from growth companies. Growth companies offer higher upside potential and therefore are inherently riskier. There’s no guarantee a company’s investments in growth will successfully lead to profit. Growth stocks experience stock price swings in greater magnitude so they may be best suited for risk-tolerant investors with a longer time horizon.

Value Investing

Value investing is about finding companies whose stock prices don’t necessarily reflect their fundamental worth. Value investors seek businesses trading at a share price that’s considered a bargain, and as time goes on the market will properly recognize the company’s value and the price will rise.

Additionally, value funds don’t emphasize growth above all, so even if the stock doesn’t appreciate, investors typically benefit from dividend payments. Value stocks have more limited upside potential and therefore can be safer investments than growth stocks

Growth vs. Value stocks

Growth stocks:

– More “expensive” – Investors are willing to pay high price-to-earnings multiples and their stock prices are high relative to their sales or profits. This is due to expectations from investors of higher sales or profits in the future, so expect high price-to-sales and price-to-earnings ratios.

– High earnings growth records – While the earnings of some companies may be depressed during periods of slower economic improvement, growth companies may potentially continue to achieve high earnings growth regardless of economic conditions.

– Riskier – They’re expensive now because investors expect big things. If growth plans don’t materialize, the price could plummet.

Value stocks:

Less “expensive” – Their stock prices are low relative to their sales or profits.

– Priced below similar companies in industry – Many value investors believe that a majority of value stocks may be more suited to longer-term investors and may carry more risk of price fluctuation than growth stocks.

Less risky – They have already proven an ability to generate profits based on a proven business model. Stock price appreciation isn’t guaranteed though – maybe investors have properly priced the stock already.

Which strategy — growth or value — is likely to produce higher returns over the long term? The battle between growth and value investing has been going on for years, with each side offering statistics to support its arguments. Some studies show that value investing has outperformed growth over extended periods of time on a value-adjusted basis. Value investors argue that a short-term focus can often push stock prices to low levels, which creates great buying opportunities for value investors.

History shows us that:

– Growth stocks, in general, have the potential to perform better when interest rates are falling and company earnings are rising. However, they may also be the first to be punished when the economy is cooling.

– Value stocks, often stocks of cyclical industries, may do well early in an economic recovery but are typically more likely to lag in a sustained bull market.

Both growth and value stocks have taken turns leading and lagging one another during different markets and economic conditions. Many financial planners be lieve value investing works in mature markets. India has many growth companies, which if invested in can generate alpha. Value funds can be a part of one’s portfolio even in a bull market, if one is ready to hold the fund long enough to make up for periods of underperformance.

Longer time period gives the fund time to discover or unlock the value of the stocks. Value funds, due to their lower standard deviation and beta, are good for conservative or first-time investors.

When investing long term, some individuals combine growth and value stocks or funds for the potential of high returns with less risk. This approach allows investors to, in theory, gain throughout economic cycles in which the general market situations favor either the growth or value investment style, smoothing any returns over time.

The fact that growth stocks have so strongly outperformed value stocks in recent years is, in fact, one of the arguments being made for value stocks rising to prominence in 2017. The success of either value-investing or growth-investing strategies tends to go in cycles, and the exceedingly strong performance of growth stocks has analysts arguing that such stocks are overextended and due for a correction. In addition, analysts argue that value stocks have taken a beating and that such stocks may well be poised for a recovery in 2017.

Rising interest rates commonly favor companies in the financial sector; higher rates usually mean banks can generate higher profits on loans. Good news for financial stocks could well be good news for value stocks overall A technical analysis argument can be made in favor of value stocks, too. While growth stocks tend to have higher P/E ratios than value stocks, the differential entering 2016 is at historically high levels, and contrarian investors might argue that the gap is due to shrink.

By Nishad MUKHERJI

 

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