Growth investing vs. value investing is a topic that often comes up among the investment public. Investors have a broad menu of investment products to select. Classifications within specific industries like technology and consumer staples are standard. Alternatively, sorting equities by size or market capitalization is common. These classifications define a particular company or describe the investment focus of individual mutual funds.
Similarly, growth and value are standard classifications for investments.
Mutual funds are defined by the equities in which they invest. Growth or value mutual funds tend to buy blocks of shares that bear the corresponding profile. Growth funds invest in growth stocks, primarily, while value funds focus on value equities.
What is Growth Investing?
As the name suggests, growth fund managers reach for stocks that focus on growing near-term revenue and profits, often reinvesting profits in business expansion, capital equipment, or acquisition.
However, there are risks to growth investing. While continually expanding, investors enjoy the benefits of rising share prices. When external forces intervene, such as a market downturn, growth targets can become difficult to achieve, and shares can stall or drop as a result.
Growth stock price-to-earnings ratios often exceed the average.
What is a Value Investing?
Value fund managers search for companies whose share prices may be notably lower than their fundamental value. This differential can result from a recent disappointing earnings report or external factors that affected the price temporarily, but a rebound could be on the way.
Comparing the intrinsic value and the current share price can project the potential opportunity of the stock. The Discounted Cash Flow is among most popular valuation methods used for determining a stock’s intrinsic value. Determining intrinsic value alerts the investor about whether a stock is overvalued or undervalued at a given time. For the value investor, a highly undervalued stock may signal buying opportunity.
The price-earnings ratio is usually lower than the market average for value stocks.
Pros and Cons of Growth vs. Value Investing
Investors in growth stocks and funds commit to companies that they expect to achieve higher than average revenue and profit growth in the future. The share prices are anticipated to grow proportionately.
Growth funds target capital gains rather than income from dividends. Since growing the business over the long run is important, reinvestment of profits is essential. Whether a small-cap, mid-cap, or large-cap company, investors are always looking for indications of growth positioning.
However, the main risk of growth investing is that unexpected conditions can arise that substantially interrupt growth projections. If the causes of these disruptions are external, some long-term investors take these in stride as long as the company business model remains viable.
Value investing is dependent upon stock prices eventually closing the gap between the existing pricing level and its perceived fundamental value. The return on well-timed value investing can be substantial.
However, the principal risk is that sometimes this gap does not close. If the market has already priced the equity at the “right” level, then nothing is gained, and the intrinsic value becomes meaningless.
Which Types of Investor Benefit from Each?
Investors with confidence in companies or funds to generate positive growth are growth investors. Many growth investors are long-term players who achieve wealth by staying invested as the companies continue to grow and prosper. However, most businesses eventually arrive at a point where high growth is no longer sustainable, and the price rise of the stock begins to stabilize or diminish.
Investors who are seeking to gain from a perceived pricing inequity are value investors. These investors tend to be analytic and readily pounce on the “safety margins” between existing and intrinsic value. While sometimes the margin does not close, value investors believe that buying stocks while “on sale” is the truest path to gaining wealth.
Historical Performance of Growth Investing vs. Value Investing
While there have been some differences in performance among the market capitalization categories of growth and value stocks, the average performance results in the 26 years from 1990 through 2015 appear to be consistent.
According to Fidelity Investments calculations, value investors fared slightly better than growth investors in each category. While the U.S. S&P 500 achieved an Average Annualized Return of 9.29%,
- U.S. large-cap value investments boasted gains of 9.03% while U.S. large-cap growth investments garnered 8.60%.
- Similarly, U.S. mid-cap value stocks gained 10.49% while U.S. mid-cap growth stocks returned 9.72%.
- From 1990 through 2015, U.S. small-cap value stocks returned 10.19% while small-cap growth stocks returned 8.32%.
Investors may choose to select blended funds, ones that employ both growth and value techniques. The famed investor, Warren Buffet, is considered to be a proponent of both styles of investing. He claims that “growth and value investing are joined at the hip.” The best situation, he says, is to find a company with a growth philosophy that happens to be undervalued.
If you have any questions about growth investing or value investing or you would like to talk about hedge fund investing in general, we invite you to contact our Canadian based Hedge Fund. It will be our pleasure to answer your questions about hedge funds investments.