Growth investing and Value investing are essentially two contrasting investment styles offered by funds. Both mean different things and represents the stock-picking methodologies used by the Fund Manager. While there are funds that tie themselves to either one or the other style, it has been observed that most funds tend to follow a mix of the two styles. But what exactly is Value Investing and Growth Investing, and which one is better for you? Lets explore.
Under the value investing philosophy, a fund manager picks stocks that are perceived to be quoted below their intrinsic worth or stocks that command valuations lower than those seen in the industry or in the market. He does this in the belief that they will be worth more in the future. Normally, such stocks exhibit low price to earnings multiples and at times also show high dividend yields. Therefore, a fund manager following the value trading approach does not need to trade actively. Once the stocks have been identified and picked, all he has to do is wait for them to realize their potential value.
Fund Managers, who follow Value Investing philosophy, will buy the stock, if they believe it is under priced and sell it, if they believe it is over priced. The art most value investors try to master is buying stocks of good companies going through a rough patch, because that is the time when the stock price will be under priced. Value investors would then ride out the rough patch and reap in their gains during better times, eventually selling them when their fair value is reached.
Value Investing Pros:
- Reduces risk of under performing by choosing investments which have a built in “safety net”
- “Hot” stock tips, hype, and mass hysteria do not affect the decisions a value investor makes
- Produces steady, consistent gains that regularly outperform the Market Index
Value Investing Cons:
- The potential returns for value investing are smaller than those of growth investing
On the other hand, growth investing is very different. Stocks picked under this approach show high revenue and earnings growth. A fund manager, under the growth investing approach, therefore bets on continuously rising earnings and does not look at valuations. Such stocks normally exhibit high price to earnings multiples as the underlying assumption is that fast paced earnings growth will continue to dilute P/Es.
Thus, such Fund Managers look for stocks that will grow faster compared to its industry or the overall market. Growth investors focus on stocks trading at high Price to Earnings (P/E), Price to book (P/B) ratio and do not care much about dividend yields. In short, growth is defined based on fast growth (high growth rates for earnings, sales, book value, and cash flow) and high valuations (high price ratios and low dividend yields).
Growth Investing Pros:
- Potential for incredible returns in a short period of time
Growth Investing Cons:
- Hot stock tips, rumors, hype, and market hysteria are not reliable sources of information to act upon
- Failure to relate the stock price to the company value leads to purchasing overvalued stocks
- Safety net is low or non-existent
- Market downturns hit growth stocks far harder than value stocks
- Potential for total loss
Growth Investing vs. Value Investing : Which Is Better And Why?
As mentioned above, both styles have their positives and negatives and make different demands on their fund managers:
In value investing, the fund manager has to ensure correct stock valuation as well as the right time of entry – both being equally vital as he would not like to get too early into a stock. Value investors generally plan to hold the stock for a longer duration, since they believe over a period the stock will come out with flying colors. Value investors are generally patient investors.
In growth investing, it is essential for the fund manager to identify businesses that face little threat of erosion so that earnings growth of those companies are not impacted. Growth investors believe that soon the company will grow rapidly and so will its stock price. Growth investors are generally in for short time frame compared to value investors. In general, value stocks tend to hold up better during stock market downturns.