PHUKET: Many investors do not understand the differences between growth stocks and value stocks, with the latter often being synonymous with Warren Buffett, the disciple of Benjamin Graham, who’s classic 1949 book The Intelligent Investor is considered the value stock investing bible.
Growth stocks tend to be high-quality stocks of successful companies whose earnings are expected to continue growing at an above-average rate relative to the overall stock market. For that reason, growth stocks tend to have high price-to-earnings (P/E) ratios and high price-to-book ratios.
This means that some investors may view growth stocks as being ‘expensive’. However, growth stocks should be viewed the same way you would view high-performance cars. For example, you will pay more for a Ferrari than you will for a Volkswagen, but the former will give you a much better performance. That’s why they cost more.
On the other hand, growth stocks can come with more risks as they tend to fall harder on adverse news or any earnings report that does not live up to the often lofty expectations of Wall Street.
Value stocks generally have good fundamentals or potential, but come with low P/E ratios and price-to-book ratios because the market is valuing their shares below their actual or potential value. There can be many reasons why this occurs and often it’s because the company is having problems that concern investors, the stock (or the sector it is in) has fallen out of favor, or the stock is not yet well known enough on Wall Street.
Investors in value stocks tend to have a long-term time horizon and are betting that the market will eventually recognize a value stock as being undervalued. On the other hand, and as with the items marked down in a store’s discount bin, sometimes you are getting what you pay for, such as something that is actually damaged. Plus, there is always the risk that the overall market will never recognize a value stock’s true worth.
Investors also need to remember that even when Warren Buffett invests in a so-called value stock or company, he isn’t overly concerned about whether or not the market will eventually recognize its true worth. What he is concerned about is how well the company can make profits and cash-flow, because often he is essentially buying the entire business – not just a few shares.
WHICH STOCKS TO INVEST IN
Growth and value stock investing are two different investing styles with neither approach guaranteed to be a winner and both coming with their share of risks. There’s also no clear historical data pointing to which investing style has conclusively led to the highest overall returns over time.
Moreover, the market tends to favor one form of investing over the other in cycles and not both at once. For example, value stocks tend to do well early in an economic recovery, as they are often in cyclical industries that get beaten down during recessions and bear markets, while growth stocks tend to lead bull markets when interest rates are low and corporate earnings are increasing.
Since growth and value stocks tend to not move in the same direction at the same time, investors should be invested in both types of stocks to achieve better overall portfolio returns and lower their risk through diversification. In fact, that’s usually the investing strategy employed by most professional fund managers with even Warren Buffett once remarking that ‘growth and value investing are joined at the hip’.
Still have questions about investing in growth or value stocks?
Don Freeman, BSME is president of Freeman Capital Management, a Registered Investment Advisor with the US Securities Exchange Commission (SEC), based in Phuket. He has over 15 years’ experience working with expatriates, specializing in portfolio management, US tax preparation, financial planning and UK pension transfers. Call for a free portfolio review. Don can be reached at: 089-970-5795 or email: [email protected]
— Don Freeman