Mar
15
2016

Value versus Growth Investing

Growth and value investing are one of the most debated topics in the investment world and one has to understand both these approaches before adopting one over the other.

So let us first look at both of them and then try to bring out contrasts in them.

Growth Investing:

Investors advocating growth investing believe that the stocks that have been delivering better than the average earnings-growth and look promising to do so in future are better to invest. Growth companies are one of the best growth potential companies within their sector of similar companies.

These companies have generally high Price to Earnings ratio (PE ratio) and high Price to Book ratio (P/B ratio) as they have fairly high market price.

Value Investing:

Value investors invest in value stocks. Value stocks are the one that are currently priced lower than the stocks in the same category. The value stocks are believed to have good and sound fundamentals but due to some recent negative news or temporary factors have made investors lost their confidence with the stocks and it brought the price down. The lost investors confidence is believed to be regained again and that the stock will gain its true price.

Thus it is true to say that value stocks are those that are currently undervalued by the investors. For value stocks the current market price sometimes become lower than their intrinsic value. These stocks have generally lower Price to Earnings ratio (PE Ratio) and Price to Book ratio (P/B ratio).

Risk associated:

Growth stocks are generally over-priced in the current market and thus have comparatively higher risk associated with them. These stocks may carry forward the high earnings growth in future or they might face corrections as well. Hence are more fluctuating and could result in steep dips if exit is not planned properly.

Value stocks on the other hand are less volatile and hence comparatively less risky. However they can actually take decent time for other investors to realize the actual value and start investing into it and thus rebounding the price. Hence value stocks pay their returns in long term investments.

Growth vs Value investing – what wins:

 

Value Investing Growth Investing
Stocks currently underpriced but with strong fundamentals, low PE ratio, low P/B ratio Stocks with high earnings growth than peers, high PE ratio, high P/B ratio
Good returns in long term Good returns in comparatively short term
Less volatile High volatility
Less associated risk High associated risk

As discussed so far both the approaches have their own benefits and risks associated with each other. On one hand growth investing could give you better returns in relatively short duration but then has volatility risk associated with it; what if the stock was just overpriced with bad fundamentals and finally crashed.

On the other hand value stocks provide returns in long term with less risk, but what if the stock took forever trying to rebound but actually never does so.

So may be an approach combining both these strategies could work better. Selecting a couple of both growth and value stocks and diversifying the investment can give the best of both.

It has been proven by few investors that growth investing works best during a growing economy as the stock is more volatile and has high earnings growth. On the other hand during stagnant/slowdown economic cycle value stocks are believed to perform best due to their strong fundamentals and less volatility. So a best match of both the strategies could protect you throughout the economic cycle.

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