Hi all, does anyone have a concise view of what these two terms truly mean in a PE sense? My understanding is that a 'value' fund seeks targets they view are priced below the intrinsic value and thus generate value by bringing the company up to intrinsic value through EBITDA growth/multiple expansion. That is intuitive to me
But 'growth' means paying a premium multiple for a target that will grow EBITDA significantly by exit. But what generates value in a 'growth' strategy? If everyone knows a company is going to grow EBITDA by 20+% over next 5 years, the multiple paid will be extraordinarily high; while exit multiple will likely come down because growth will flatten. So where is the alpha/value coming from? All things held equal vs. a value strategy (from a leverage, deal structure pov) Thanks!!
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"In his letter to Berkshire Hathaway (NYSE:BRK.A) (NYSE:BRK.B) shareholders in 1992, Warren Buffett wrote:
Most analysts feel they must choose between two approaches customarily thought to be in opposition: "value" and "growth." Indeed, many investment professionals see any mixing of the two terms as a form of intellectual cross-dressing.
We view that as fuzzy thinking (in which, it must be confessed, I myself engaged some years ago). In our opinion, the two approaches are joined at the hip: Growth is always a component in the calculation of value, constituting a variable whose importance can range from negligible to enormous and whose impact can be negative as well as positive.
Companies trading at relatively low valuation ratios are usually referred to as value stocks, while those with superior growth rates and higher than average valuations are generally called growth stocks. But Warren Buffett believes these simplifications are severely lacking, as growth and value are intimately related. Elaborating on this concept, Buffett wrote to his shareholders in 2000:
Common yardsticks such as dividend yield, the ratio of price to earnings or to book value, and even growth rates have nothing to do with valuation, except to the extent they provide clues to the amount and timing of cash flows into and from the business. Indeed, growth can destroy value if it requires cash inputs in the early years of a project or enterprise that exceed the discounted value of the cash that those assets will generate in later years. Market commentators and investment managers who glibly refer to "growth" and "value" styles as contrasting approaches to investment are displaying their ignorance, not their sophistication. Growth is simply a component - usually a plus, sometimes a minus - in the value equation."
The value comes from paying a slight discount to how much the company will be worth in the next 5 years. And nobody "knows" that EBITDA will grow 20%... projections are never correct and the price paid just depends on the confidence of the investor based on his diligence that the company will perform in a certain way.
Agreed for value, I’ll even go further and take an eaiser example: if a firm (in classic sectors) trades below book value, the. Theoretically you could buy the firm, sell all of its assets and end up with a profit, that’s value investing effectively.
Now for growth, take google, everyone assumed that their ~15% growth rate would flatten at some point, except that for the last 20 years, they have consistently achieved these ~15% growth. So a good growth investor (in public markets) will find and investment that will grow aggressively, over a period of time and the alpha will come from the fact that the firm will beat the expected slowdown in growth.
At least that is my understanding of the two options.
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