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Value Investing and Growth Investing are two of the most popular ways of investment. Both these strategies have been used by several ace investors to build their wealth. In this article we will explore these two ways of investment in a detailed perspective:
Value investing has been one of the most favored strategies used by long term investors. The basic idea of value investing is to buy stocks at valuations less that the intrinsic value. This is in contrary to the belief that stocks priced in all the information that is available and also events that are likely to occur in future. The value investor looks for differences between the market price and the intrinsic value of the stock.
The earliest concept of value investing came from the investment strategies used by Ben Graham and David Dodd in 1928. Value investing generally takes into account various fundamental aspects of the company like earnings, dividends and cash flow. It looks for stocks that are undervalued in the current market situations and expect the stocks to get fairly priced in due course of time.
Some important points of value investing:
1. Studying the financial aspects- Important parameters like asset value, outstanding debt and financial liabilities which play a key role in the fundamentals of the company should be studied. The ‘intangible’ assets like intellectual property, patents and trademarks should also be considered in the analysis.
2. Reason behind low prices- Investors should not rely on historical prices to determine the point of bargain hunting. The current market price of the stock should be compared to the intrinsic value of the company in current market situations and not on historical values.
3. Fundamental parameters- Important fundamental parameters like P/E ratio should be studied to compare earnings of the company to the current stock price. Stocks with low P/E, or low P/B ratio is generally regarded as good buying opportunities.
Growth investing strategy focuses on the long term growth potential of the company for appreciation in stock prices. It also takes into account the fundamentals of the company while analyzing the stocks, but the difference with value investing is that in growth investing the focus is on buying good stocks at good valuations while in value investing the focus is on the future potential of the company without much regard to the current scenario.
Growth stocks are often the stocks of new companies which show opportunities for rapid progress. However, whether the tide will continue to bloom will decide the fate of the investor.
Some important points of growth investing:
1. Check the earnings history- The earnings per share (EPS) of the stock over the last few years can give a good idea of how the company has been doing. The growth in EPS can reflect the growth story of the underlying company.
2. Estimating forward earnings- Since the idea is to identify growth, the analysis of forward earnings is very important. The investor can use the research reports of various brokerage houses and then do a bit of research himself/herself for this. Generally small caps and midcaps show greater growth prospects than large caps though they carry more risk.
3. Competitive Advantage- When looking for growth specific stocks it often good to buy stocks which have a dominant presence in their area of operation. Companies which have patents over certain technologies or ideas often prove to have a high competitive advantage. Companies facing high competition often face high pricing pressures and in turn the growth outlook faces lack of clarity.
4. Good management- Efficiency of the company’s management is perhaps the most important factor when choosing growth stocks. Ultimately, it is the management which decides the policies of the company.
5. Government policies- It is extremely important to keep a track of how the government policies’ would impact the company of the underlying stock. Often the government looks to give certain sector incentives or tax benefits which in turn give a positive outlook to the companies which operate in the sector.
Growth investing v/s Value investing
Growth investing is a strategy in which investors select stocks of companies that are expected to have a high growth rate. They expected the stocks of the companies to outperform the market and in the process achieve capital gains.
Value investing, is a strategy in which investors select stocks of companies that are assumed to be trading a discount to the intrinsic value. For this metric such as a company’s price-to-book ratio or price-to-earnings ratio is used in order to estimate a company’s worth.
Some great investors
Philip Fisher was one of the greatest investors in the world who followed the growth investing philosophy. Fisher began his career on Wall Street in September 1929 one month before the beginning of the Great Depression. In 1931 he started his own investment firm, Fisher & Co. The firm followed a growth investing philosophy.
As the American economy pulled out of the Depression, Fisher began investing heavily in companies that grew profits. One of his largest investments was in Motorola, which he bought in 1955 when it was a young start-up held it until his death in 2004. He said that if a company is managed well and it is able to grow, there’s no reason to sell it. Benjamin Graham on the other has been a follower of Value Investing. He also launched his career during the Great Depression and found tremendous success with the philosophy of Value Investing.
However, Warren Buffett has said that his philosophy is “15 percent (Philip) Fisher and 85 percent Benjamin Graham” meaning that follows both Growth and Value Investing.