For hundreds of years, companies have been issuing stocks and bonds, while investors looking to make their money work for them have been buying these securities.
Today, trillions of dollars are circulating through stock markets around the world, as people continue to invest money in stocks, in the hope that companies they’ve invested in will flourish, thrive, and yield investors a handsome return.
P.S. You might want to read our entire deep dive on how deep value investing works.
While hundreds of millions of people in the UK, US, Asia, Europe, India and beyond own stocks, not everyone is able to turn massive profits on the stock market and accumulate a small fortune from buying shares in a few promising-looking companies. However, many of those who do succeed in the stock market tend to have one thing in common—a strategy.
Throughout history, there have been countless investment strategies, fads, techniques, and tips. While investors might swear the reason behind their success is the application of a particular strategy, there is no “one size fits all approach” when it comes to trading stocks and other securities.
There are, however, more common and simple methods of effectively choosing which stocks to own, which can be a great starting point for anyone looking to make a foray into the world of the stock market.
In this article, we’ll be breaking down two popular investment strategies that have been around for some time: value investing, and growth investing.
Below, we’ll answer questions like what is value investing, what is growth investing, why value investing or growth investing, and which of them is right for you.
What is Value Investing?
The goal of value investing isn’t to find the best companies on the stock market; rather, it’s to find the best-priced stocks on the market. The value investing strategy was introduced to the world by the well-known economist Benjamin Graham, and has since risen to super-stardom since being widely publicized by multi-billionaire Warren Buffett.
Value Investing Strategies
Identifying Value Stocks
Value investing and deep value investing begins with identifying value stocks through different valuation multiples.
These valuation multiples come in a variety of different ratios, and help equip investors with an objective tool to measure how appealing the price of a particular stock is at a given time.
Determine Price-To-Earnings Ratio
An easy and popular way to compare stocks and determine which one might offer better value is by using price-to-earnings or price-to-book ratios.
These calculations, commonly referred to as the P/E ratio and P/B ratio, are measures that help investors identify when a stock is being traded at a low price relative to its true value.
These values can be calculated by dividing the price of a stock by the earnings per share (for P/E ratio) or the book value per share (P/B ratio).
A lower P/E or P/B ratio is desirable to value investors and is often a key component of the value investing strategy.
Determine Price-To-Sales Ratio
In addition to P/E and P/B ratios, value investing strategies can also make use of the price-to-sales ratio or P/S ratio, which is reached by dividing the price of the stock per share by the company’s revenue per share.
“Buying The Blood”
While value investing strategies rely heavily on financial calculations and ratios to determine value, there are also some more concrete figures in a company’s books that value investors implement in their stock-picking strategies.
Oftentimes, value investors will dig through stocks that have recently hit 52-week lows, hoping to find stocks that have not yet recovered from a recent dive, buy-in at a great price, and wait until the company can get back on its feet before selling for a profit.
Some helpful indicators used by value investors include companies whose equities match or exceed its debt, assets are 2x or more its liabilities, and whose share price trades at or below the book price of its tangible assets (meaning that if a company were to liquidate its assets immediately, the value investor’s shares would still be worth more than the price he or she paid for them).
Benefits Of Value Investing
Sizeable Returns
Value investing offers several benefits to investors, but most notably the potential for sizeable profits.
Since the value investor is primarily concerned with buying stocks at bargain pricing, there is generally a comfortable margin of error and the hope that since these companies have fallen out of favour with other investors, that the only place to go is up.
Value investing done correctly should offer its proponents the opportunity to buy a discounted dollar in the marketplace of stocks, and in cases where the price per share is less than the book price of the company’s assets, offer immediate equity and a good chance of profiting.
Simplicity
Another benefit of value investing is simplicity.
It can be easy to get caught up in all the different factors that might make a stock seem attractive, but value investing adheres primarily to definable, straightforward characteristics, and doesn’t emphasize things like a company’s business model or the effectiveness and quality of its upper management.
Value investing sticks to a set of principles and consistently uses financial data to justify every action.
Potential For Growth
Lastly, though value investing is more concerned with the price of the stock than anything else, the potential for growth is always what value investors love to see.
It’s not something value investors emphasize or depend on, but it’s certainly sweet when it does happen. Value stocks can often be smaller and riskier than some other stocks, so it’s a nice consolation prize for value investors when a value stock manages to grow and yield even greater returns than the investor initially anticipated.
If you want to learn more about value investing strategies, you can always take a look online at some of the best value investing books for more detail.
Downsides to Value Investing
Value Stocks Are Risky Investments
While we’d all love to believe that a good value investment always leads to massive gains that outpace the market, reality has to disagree.
Just as all stocks are not immune to losses, value investing can also result in losses.
When a value investor purchases a value stock, the hope is always that the company has reached its nadir and has no choice but to rebound and send its stock price soaring.
Again, reality begs to differ, and the most severe downside of value investing is that the stock loses its value altogether.
And, while this can happen to any stock, regardless of the strategy its owner used to purchase it, value stocks do have a tendency to be riskier than the dependable brand names in the large-cap index funds.
Value Stocks Tend To Be Undervalued For A Reason
This reason usually means that the company is struggling in one or more ways and that most investors have lost confidence in the business for the time being.
Since value investing doesn’t pore over the inner workings of the company, it’s quite possible that a value stock is not a great company, but just one that is trading below its value. Nevertheless, the potential for the already shaky company of a value stock to lose its footing completely is a very real, very scary risk.
What is Growth Investing?
Growth investing is one of the most ubiquitous stock trading strategies around, and continues to serve its investors well.
Growth investing prioritises the high-quality stocks of the most successful companies.
Growth companies are those that have performed well historically, and that investors believe will continue to perform well.
Using a variety of financial measurements and indicators of past performance, growth investors conduct extensive research prior to carefully choosing which companies to invest in.
Growth Investing Strategies
Growth investing strategies, like value investing strategies, often use financial figures to help determine which companies will be suitable investment choices that fit the strategy’s mould.
As its name suggests, growth investing focuses on the growth rate of companies, looking for impressive growth throughout its past, and the prospects of further growth in its future.
For a smaller company that has started growing more recently, growth investors often expect to see returns of 10% or more over the most recent five-year period, while larger companies that are more well known may have slower growth rates of 5-7%.
Return on Equity
Another item on the strategic checklist of the growth investor is a return on equity.
Return on equity, or ROE, helps to tell us how efficient a company is at utilizing its assets to generate earnings.
The equation for ROE is net income divided by book value.
Growth investors want to know how a company’s return on equity compares to other similar companies in the same industry, and will usually look at a longer time frame such as five years.
Stock Earnings Per Share
Growth investors are also known to use a stock’s earnings per share, or EPS, to see how profitable a company is.
You can arrive at the EPS by dividing a company’s net earnings by the number of outstanding shares. Growth investors want to see companies with higher earnings per share compared with similar companies they are competing with. The company with the higher EPS usually demonstrates a more efficient operation by generating more profit per dollar spent.
This metric is particularly valuable to growth investors because it can often be an important indicator in the number of dividends a company pays to its shareholders.
While these are just a few of the many strategies that can be used to search for and select growth stocks, it’s also quite possible for a company to experience rapid growth without the aforementioned financials.
Depending on the type of growth investor and his or her risk tolerance, a growth investor could theoretically invest in just about any stock, which may prove itself capable of rapid growth. Growth investors are always keeping their eyes and ears open to any stock they believe has significant potential for future growth.
Read More: How To Invest Exactly Like Warren Buffett
Benefits Of Growth Investing
Relative Safety
The benefits of growth investing range from relative safety and security to sustainable and surprising gains. Because growth investors generally flock to companies that have a great business model and are already proving themselves major players in their respective industries, growth investing offers some security, though it is never guaranteed.
Most growth companies have a sturdy foundation upon which to stand, and have not only been in operation for some time but have demonstrated continued growth and profitability.
This being the case, it’s less likely that a stock chosen by a growth investor will fluctuate wildly, having established itself in the market.
The Statistics (Rarely) Lie
Another benefit of growth investing is that the numbers support the strategy.
Growth investors identify a company’s growth over an extended period of time, taking into account everything from how much efficiently it uses its funds, to how much money it pays its investors in dividends.
Rather than just assume a company has the potential to grow, growth investors focus on tried-and-true methods and a history of strong performance to help predict that the upward trend in a particular company will continue over the next several years.
Ride The Trend
Finally, one of the great things about growth investing is that the price doesn’t always matter. Sure, growth investors look at the price of a stock, but oftentimes they will buy it even if it is a bit overvalued.
This is simply because they believe that despite the high price tag, the company’s success will be continued—so much so that the investment will be well worth every penny paid, and then some.
Downsides to Growth Investing
Historical Performance Doesn’t Always Guarantee The Future
Growth investors do their best to predict the future based on historical evidence and past performance, but even a decade of incredible growth and profitability does not guarantee a single penny in the eleventh year.
Growth investors can’t tell what a stock price will do in the future and, like all investors, are at the mercy of the market’s twists and turns.
Buying High
Another widely acknowledged downside to growth investing is the chance that you’ll overpay for a stock. In complete contrast to value investing, growth investors don’t need a stock price to present itself at a discount before they are willing to pull the trigger.
Sometimes, buying a growth stock at a fair price or even at a price above its intrinsic value doesn’t carry much significance, and the investor can still make money over time so long as the company performs well in the future.
Other times, though, a growth investor can overpay for a stock, wait for it to grow, and be terribly disappointed when he or she has to acknowledge that price paid was too high and may ultimately result in selling at a loss.
Low Risk = Low Returns
Finally, though the potential for growth appears to be present in growth stocks, the size, reputation, past performance, and publicity of most growth companies prevent them from dramatic swings.
While this may provide some level of assurance that growth stocks won’t suffer massive double-digit losses in a single day, it also means that the likelihood of double-digit gains are unlikely, so you’ll have to be patient, hang on to your growth stocks, and wait until the annual dividends are announced and paid out.
Which Is Better: Growth Or Value Investing?
Unfortunately, there’s no definitive winner in this race, and our best answer to the question is both. History has shown us that at times, value investing is king for yielding incredible and sustainable returns. But there have also been bad times to be a value investor—times when other trading strategies outperformed the seemingly untouchable value stock model.
Take the 2008 financial crisis, for instance. Many people lost money during the massive recession, but value stocks suffered an even harder hit than growth stocks. Then, in 2009, while both value and growth stocks rebounded, growth stocks outperformed value stocks by a whopping 10%+ over the one-year period.
Conversely, there have been times where growth stocks appeared to be the undisputed leader in stock strategies. 2017 was a grand old time for growth stock investors, who turned a profit of nearly 30%, while value investors enjoyed a return of around 15%, modest by comparison. Though, like value stocks, growth stocks have certainly had their lows, too.
During the tail-end of the dot-com bubble in 2000, growth investors were being thrashed by losses of 22%; meanwhile, the value investors managed to tack on around six percent to their portfolios.
In conclusion, there is no investment strategy that is foolproof.
As the data will show, there is cause for both celebration and turmoil if you are a value investor or a growth investor. The best course of action, regardless of your preferred strategy, is to diversify your investments.
Put yourself in a position to succeed and enjoy the good times, while hedging your risk and minimizing your losses during the bad ones. A nice, diverse portfolio of growth and value stocks will position you for the greatest chance of success, and help protect your investments against dramatic losses.
