Value vs. Growth Investing
(Senior Monkey, 80
Points)
on 4/11/12 at 12:15pm
Obviously these two investment styles are derived from different schools of thought and have both had their successes and shortcomings over the past 30 years. How do you distinguish these mindsets for investors? Do you find yourself partial to one or do you learn to develop that mindset based on where you work and who you interact with? I would be curious to hear people's opinions on this and how they would compare and contrast the two styles.
Warren Buffet is all the
Warren Buffet is all the proof I need that Value > Growth. Value tends to be based in actual fundamental valuation while Growth is far too speculative for my taste.
"One man with courage makes a majority." — Andrew Jackson
I find that these terms are
I find that these terms are misleading. I for one do not make bets solely on what I think the market is pricing too cheaply nor do I focus solely on a company's growth prospects. In reality you should use a combination of the two. They are not mutually exclusive IMO
I don't think the two are
I don't think the two are mutually exclusive...
I think this is probably
I think this is probably controversial statement, but I believe that value vs. growth is a false dichotomy created by mutual fund ratings agencies.
If we grant that valuation is an imprecise art (and by God it is), then we need to think about the constituent parts of what makes goes into a valuation.
So what goes into a valuation?
- Assets less liabilities.
- Near term profits ("certain" profits)
- Future profits ("uncertain" profits)
If any one of those things is improperly valued by the market, then there is an opportunity to invest in something that is undervalued. Value investors often focus on the first two, growth investors on the last. However, there are periods of time where one or more of those factors will be systematically undervalued and will allow the perceptive investor beat Mr. Market time and again.
Here's an interesting mental experiment.
Say you are considering an investment in an asset-less, liability-less firm that is currently losing $1M a year. However, you know with perfect certainty that it will earn $1M in profits next year, 50% certainty that it will earn $2M the year after that (50% certainty it earns $1M), and 50% certainty that it will double profits each year for the next five years (50% certainty it will remain flat).
If the market P/E is 10x on trailing earnings and corporate profits are flat growth (so an implied 10x forward earnings too), what is the firm worth?
The answer certainly isn't zero. If something is going to be profitable next year, there's a concrete value you can assign to it.
Is it worth 10M (10x forward earnings)? Some investors would say yes because future profit streams are significant less certain. There is the possibility that your profits will stay flat.
Is it worth MORE than 10M? This is where I would place my bet. Here's the reason. There is uncertainty about what profits will be but the expected value of those future profits is actually pretty high. If the stock's selling for a 10M market cap, I'm happy to invest in this company because the expected value of future profits are significantly undervalued. I don't need precise knowledge of future profits to know that this is a deal.
My argument, while coached in value terms, describes how a growth stock can be undervalued because of its growth potential.
A company that is growing profits at 15% a year, selling for 15x current net income can be deeply undervalued. A stock that expects to liquidate its business in the next five years, selling at 10x current net income is often not.
Growth tends to have a higher
Growth tends to have a higher risk tolerance and a strategy that lends itself towards momentum trading. You have to be willing to overpay for a stock today, looking for it to grow into a higher and higher valuation in the future. Normally they are also growing faster than other companies around them which tends to lend to thinking they are worth more than a comparable, slower growing company. Thus, they trade at rich valuations where all it takes is one slight misstep to send the stock reeling. Take a look at Netflix whenever people worry about subscriber growth or linked-in when worries about competition arise. Normally they get flattened. Growth, to me, represents opportunity or at least the prospect of opportunity. Anyone can grow absurdly fast utilizing a scheme like Pandora or Grupon. The trick is to grow quickly and profitably, a la Apple. That is something I'm willing to pay up for, the other two not so much.
Value has much longer time horizon and really encapsulates what finance is all about. Understanding and valuing a company from the ground up, understanding why it's valuation is lower than it should be and then reckoning whether that company is going to do better than expected over the long run. The problem with value can arise with companies like RIMM which is bandied about as being 'undervalued.' In all likelihood they are a dying company that simply got out innovated in an industry that relies on dynamic change and growth. You simply can't survive when you make awful products. Is it technically undervalued via metics? Probably. Don't, however, confuse cheap with value.
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Why choose when you can have
Why choose when you can have both in the same security? The best stocks are value stocks that become growth stocks.
Interesting discussion, I
Interesting discussion, I appreciate the responses thus far. I have always been more comfortable with the value investing approach myself. Ravenous, what are some examples you have in mind either today or from past results?
My favorite of all time is
My favorite of all time is Davita (DVA) circa early 2000. I was not in the industry at that time but know someone who bought a fair amount (like half a million or a million worth) at <$2.00 and still owns it today at $85. Company was thought to go bankrupt (but didn't) and had a very obvious long tail in front of it on the fattification of America and the rise of diabetes. There are lots of other, similar names overseas, including some really crazy stuff in Asia that trades for like 8x EPS with industry leading positions and a 20+ growth tail in front of it -- I found a couple that even have explicit government support preventing foreign competitors from entering. I'm not going to name names on those.
Interesting discussion thus
Interesting discussion thus far. I'd like to try and take it away from equities for a second.
I think that, as a framework, value is much more flexible in some sense (if we define value as buying things the market has undervalued). A margin of safety could, in principal, exist due to attractive valuation in any asset class or product area. You can see this flexibility in some of the the really big value investor's portfolios (ex. Buffet).
The growth investor mindset doesn't really translate as well as far as I can tell, I'd say the closest equivalent is to classical macro investing where you are trying to spot a trend early on.
Marked to Market
Interesting discussion thus far. I'd like to try and take it away from equities for a second.
I think that, as a framework, value is much more flexible in some sense (if we define value as buying things the market has undervalued). A margin of safety could, in principal, exist due to attractive valuation in any asset class or product area. You can see this flexibility in some of the the really big value investor's portfolios (ex. Buffet).
The growth investor mindset doesn't really translate as well as far as I can tell, I'd say the closest equivalent is to classical macro investing where you are trying to spot a trend early on.
If I had to pick one, I'd say I favor value investing, however, I think that anyone who doesn't read The Alchemy of Finance and at least reflect (heh) on the impact Soros' reflexivity concept in terms of both market and intrinsic value is doing themselves a disservice.
There have been many great comebacks throughout history. Jesus was dead but then came back as an all-powerful God-Zombie.
PennTeller wrote: I think
I think this is probably controversial statement, but I believe that value vs. growth is a false dichotomy created by mutual fund ratings agencies.
Not controversial at all. Exactly correct, and essentially what most people born after 1970 believe. "Style boxes" are a relic that made sense for periods of market history where you could make money on the long side without doing a whole lot of diligence because the market generally went up for 2 decades, so it became acceptable to overpay for future growth. "Value" investing (meaning paying less than your estimate of intrinsic value, NOT just buying stocks with low multiples) is essentially the only way to invest. It's a tautology - you're either paying less than intrinsic value or you're buying high and selling low. Paying more than intrinsic value only makes sense if there's a greater fool, and while you can make money that way it's not investing.
Growth investing on its own
Growth investing on its own is pretty hard to do successfully without incurring a lot of risk. For one, there are very few true growth companies. To be a consistent grower, you usually need to be involved in some kind of new product or service, and there aren't too many things that haven't been thought of already. Anything new and amazing tends to attract a lot of new entrants that compete away excess returns. Anything that has a barrier to entry and which grows very well is priced very high, disallowing margin of safety in the event that their new product or service doesn't ramp as expected (which is common since a lot of management teams lie). I'd rather be long something at a low multiple with a consistent business that is doing something that will allow them to grow such as a sensible acquisition strategy, cross selling opportunity, bolt on product, etc. I can't get really excited about tech stocks and other high flyers, unless I'm betting against them.
Ravenous wrote: Growth
Growth investing on its own is pretty hard to do successfully without incurring a lot of risk. For one, there are very few true growth companies. To be a consistent grower, you usually need to be involved in some kind of new product or service, and there aren't too many things that haven't been thought of already. Anything new and amazing tends to attract a lot of new entrants that compete away excess returns. Anything that has a barrier to entry and which grows very well is priced very high, disallowing margin of safety in the event that their new product or service doesn't ramp as expected (which is common since a lot of management teams lie). I'd rather be long something at a low multiple with a consistent business that is doing something that will allow them to grow such as a sensible acquisition strategy, cross selling opportunity, bolt on product, etc. I can't get really excited about tech stocks and other high flyers, unless I'm betting against them.
Great answer, as always.
"One man with courage makes a majority." — Andrew Jackson
tempaccount: PennTeller: I
I think this is probably controversial statement, but I believe that value vs. growth is a false dichotomy created by mutual fund ratings agencies.
Not controversial at all. Exactly correct, and essentially what most people born after 1970 believe. "Style boxes" are a relic that made sense for periods of market history where you could make money on the long side without doing a whole lot of diligence because the market generally went up for 2 decades, so it became acceptable to overpay for future growth. "Value" investing (meaning paying less than your estimate of intrinsic value, NOT just buying stocks with low multiples) is essentially the only way to invest. It's a tautology - you're either paying less than intrinsic value or you're buying high and selling low. Paying more than intrinsic value only makes sense if there's a greater fool, and while you can make money that way it's not investing.
Totally agree, and well said!
Being a pragmatist, value investing to me is the only method which makes sense. That being said it is the area which i have dedicated most of my study at this point. A lot of other investment strategies really leave me scratching my head. Speculating doesn't bother me, I wouldn't do it myself, but if your big enough to move the ocean when you jump into it, then sure (eg. Soros).
Further to this, I see a lot of the mathematical models in PM as gimmickery. A well hedged value portfolio really seems like the way forward. Long/Short makes sense to me too as it still hinges on fundamental analysis of the security.
"It's not until the tide goes out that you see who's swimming naked" - Howard Marks
For value investing, what is
For value investing, what is a good margin for undervalued stocks to be considered a good investment?
www.purechecks.com
vitalogist: For value
Wrong thread.
Wrong thread.
eriginal: Ravenous: Growth
PennTeller: I think this is
Interesting points from all