In the world of finance, the most difficult part is just understanding the definitions. Unfortunately, all definitions aren’t consistent – some pacts have various twists on the definitions of terms. For this conversation I’d like to take you through the two main categories of a security or investment theory. A security can also be referred to as stock, equity, certificates & shares. People often put stocks or their stock buying theory into the “growth” or “Value” category. This phenomenon is relatively new – pioneered primarily by investment research firm Morningstar. Most people don’t care what it’s called, as long as it makes them money. The basic premise is this – for value investors they concentrate on stocks whose value, in their opinion, have a discount to the intrinsic value to the company. The intrinsic value can be any definition from the breakup value, book value, hard asset value, or current value of discounted future earnings. The growth school premise is this – a company’s sales and earnings potential are the best indicators of future performance. Here the search is for momentum – companies that have rising revenue, higher financial ratios and track records of strong and steady growth. Can stocks grow fast forever – of course not.
Value stocks tend to be less affected by earnings surprises, which can lead to a less volatile portfolio. Value stocks also typically offer a higher dividend yield which helps alleviate the effect of a price drop in a stocks price to the overall total return.
Many are aware of the potential explosive growth potential of growth stocks as evident by the market in 1995 – 1999. We’re also all too aware of the volatile dive those same stocks took from 2000 – 2002. That ride felt like a 747 losing 5000 feet instantly. It isn’t a good feeling and it lasts years – perhaps taking over a decade to recover from.
Although we cannot argue that growth and value don’t have their differences, many overlap. There are growth managers who own companies traditionally defined as value stocks and vice versa. Growth stocks tend to do well when the economy is very strong and investor sentiment is positive. Value stocks tend to do well when the economy is in or recovering from recession. Value tends to favor lower interest rate environments. This puts us in a conundrum – the current situation isn’t crystal clear – we’ve got mixed signals as we typically do in finance. Let’s hedge our bets by using a bit of both styles with a bias towards value and keeping our eyes on things as they unfold. Growth and value strategies can be applied to any segment of the market – domestic stocks, foreign stocks, small stocks, large stocks, mid size stocks, etc. To further fragment the category we can see how people have blurred the lines between the two fundamental styles – we have GAARP – Growth at a reasonable price. Various firms define value as a certain discount to “appraised” value – some want a 10% discount, others a 50% discount and everywhere in between. That sounds great – come see us and we’ll show you how. Try to buy your next car with a value strategy – you want 25% of the market price. It can be done.