We all get excited when there is an India Vs. Pakistan match. It makes the world divided into two, supporting each team. When it comes to investing, we see the same battle (not that intense, of course) of investors fragmenting their opinions to support each style of investing: Value and Growth.
Value investing and growth investing are the two most basic approaches to investing in the stock market. They both signify different approaches to choosing investments. While you don’t have a side with a single investment strategy, the key lies in opting for the one that suits you the best in the puzzle of value investing vs growth investing.
The debate over value investing vs growth investing goes way back in history, with each style favoring over other under different market conditions. Enough on the teaser; let’s get deeper insights.
What Is the Difference Between Value Investing and Growth Investing?
Let’s say there are two investors, Dimitri and Mike. Dimitri thinks that the market undervalues stock A and believes it has more potential to rally. Whereas Mike thinks that stock B has been rising and has more legs to rise, given the company’s growth opportunities. In this case, Dimitri is a value investor, and stock A is a value stock. While Mike is a growth investor, stock B is a growth stock.
Of course, there are other parameters to define each style which we will see in a moment. But you got the basic drill, right?
Value stocks generally progress slowly and are perceived to be undervalued by the market. The investor betting on this stock assumes that the market will realize its true value soon and the share price will rise.
Technically, you need to analyze metrics like price-to-earnings ratio, volatility, price-to-book ratio, and dividend yield to define whether a stock is a value stock or a growth stock.
Value stocks generally exhibit low P/E, P/B, volatility, and higher dividend yield. However, it is not a thumb rule, so take it with a pinch of salt, given market dynamics can change very quickly.
On the other hand, the market overvalues growth stocks, and it is only betting on them because of the growth prospects. These stocks are the other side of the coin with higher P/E, P/B, volatility, and lower dividend yield. Investors simply bet on the company’s ability to pursue growth opportunities which later reflect in the share price for growth investing.
What Is Value Investing?
Now that you are already aware of the basic nifty-gritty about each style of investing, let’s dig a little deeper into each.
Value stocks are often well-established companies with a respected foothold in the market. For example, depending on the market capitalization, if a stock is valued at Rs. 100 but is currently priced at Rs. 80, then it is a solid value play.
Many factors go behind why the market undervalues a stock, which can be idiosyncratic or macro-level reasons. Let’s say a company is experiencing a governance issue, and the stock price is badly hammered, but industry fundamentals are still robust. In that case, a value investor might bet on the company’s stock to recover once the governance issue is subsided and the stock is back on track.
Other reasons for undervaluation could be the cyclical nature of the business, consumer behavior, and market perception, among others. Ratios like P/E, P/B, etc., along with company and industry fundamentals, are used to identify value stocks.
What Is Growth investing?
Investors preferring this style believe that growth stocks can revolutionize their portfolios. Growth stocks can be seen in any of the small, mid, and large-cap companies where growth opportunities are shining. Over and above the metrics like P/E, and P/B, which we just discussed, growth investors believe that the company has a strong potential to invest in many expansion opportunities and increase its capital expenditure in the near future.
These companies may have some innovative products or may have the ability to act fast on changing consumer requirements, creating a growth investment opportunity for investors. In short, the companies in this space have the capacity to outpace their rivals with innovative solutions and disrupt the market.
Value Investing Vs Growth Investing: Which Is better?
When analyzing whether value vs growth investing is better, returns and the time scale and degree of risk are important factors to consider. The question of which investing style is better depends on you. What kind of an investor are you?
If you are someone that is happy with higher dividends as another source of income and wants lower volatility, then value investing is a perfect fit. Value investing should not always prove valuable. Thus, you need to research well about the stocks before you invest. It can go wrong if you lack research and interpret incorrect value reflected in the share price. You must be cognizant of that fact.
As an investor, if you have a slightly higher risk-taking ability and trust the company’s management to hunt for growth opportunities to capitalize on that, growth investing is suitable for you. Higher stock price volatility, higher valuation multiples, and betting on innovation are the characteristics of a growth stock. However, some innovations can be easily replicated, may not be successful, or might not get regulatory confirmation. As an investor, you must watch out for these developments and keep close track of them to take advantage of compounding your capital.
Conclusion
As an investor, you should not feel controversial to be on either side or both sides, each to your own. There are stocks available in the market that blend both styles of investing. No style is bad or superior to others. It’s just the very nature of the market, which is cyclical, and each investing style gets its own time to perform. Over time staying invested will provide higher returns in any of the investing styles.
As an astute investor, you should closely track the company you’ve invested in. If it’s a growth stock, you must track the exponential growth in the financials and the ability to be an initiator in the market. On the other hand, if it’s a value stock, the fundamentals should be intact to bridge the gap between the intrinsic value and the market price.
FAQs
1. Could a stock serve as both a value and a growth investment?
The straight answer is a big yes. A stock can possess both value and growth characteristics, like being undervalued and showing higher revenue growth year on year. You can develop this strategy to trade this space. One such strategy is GARP (Growth At a Reasonable Price). This strategy focuses on the growth of the company while keeping an eye on valuation.
2. What strategy could an individual interested in value investing employ?
A value investor can look for companies that are trading at less than their book value or true intrinsic value. Ratios like P/E, P/B, and dividend yield can also be looked upon to identify value stocks. Typically, value investors can seek stock that they believe the market undervalues.
3. Are value stocks an appropriate investment during periods of inflation?
History says that value stocks can outperform during times of inflation. The reason could be that those companies are able to pass on the price rise to consumers and have robust pricing power. However, you should always conduct your own research to reach a conclusion.
