Saturday, 25 July 2015

Growth Investing vs Value Investing

Just started reading Common Stocks and Uncommon Profits by Philip A. Fisher. This book seems to be going into growth investing, which I think is good to compare to value investing (You can read on my thoughts on different investing styles at Value Investing and Thoughts on Investing for Dividend Yields). While both share similar ideas (such as fundamental analysis and buying stocks on their "intrinsic value"), they have some differences such as their focus on "intrinsic value" (slight difference between the two in my opinion)

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Growth investing focuses on investing in companies that would grow above the industry or stock market average through increase in its earnings per share (EPS), while value investing has a larger focus on an increasing price to earnings ratio (P/E ratio). While growth investing aims to pick up stocks that may be able to grow its EPS many times over, value investing aims to pick those shares that are sold at attractive valuations for their returns.

Growth investing seems to be able to deliver far higher returns than value investing due to the large exponential growth that some companies may experience due to the ability of their management, research teams or industry, however, the companies chosen are usually smaller companies that would be riskier and would require some diversification. While there are some big-caps (shares with large market capitalization) that are situated well in good industries, these usually do not appear to give as good returns as the small companies that are able to grow into a big cap themselves, increasing the EPS and share price along with it.

Value investing aims to get good returns for your money, which usually means getting shares when they are at their lowest prices, such as in a depression when they are selling for just a fraction of their original price yet their earning power has not been affected, Value investing does not really support the idea of going for shares that sell at P/E ratios of 30 and above while growth investing may entail that as good growth companies are viewed favourably by the market.

However, there is one point where the two investing philosophies are quite similar. Value investing, like growth investing, takes into account the future growth of the company. But then since future growth is hard to accurately estimate for the intrinsic value, value investing looks at previous earnings records of the companies and determines its intrinsic value from there. So a low P/E ratio or a low P/B ratio is usually favaourable to the value investor.

Since growth investing seems to be able to give much better returns that value investing, wouldn't it just be better if all of us switched from value to growth investing? Not so, for most of us who have to hold down a regular day job, I think it would be better for us to stick to value investing. This is due to the large amount of time needed for an individual to ascertain the growth prospects of the company. If you read Common Stocks and Uncommon Profits, you will realise that a lot of the points needed would require quite a far bit of research into the company. The author also suggests approaching different sources of information such as competitors, suppliers and customers of the company, maybe even ex-employees, which would give the insight necessary for a person to determine the growth prospects of the company.

But this is too time-consuming for the large majority of us. Having to go to different people to become well-versed in the company's affairs will take up too much time and by the time we actually do so, the company may have grown tremendously already. Doing this for several companies is definitely out of the reach for the most of us, but is necessary to ensure that the company that we have picked for growth investing is solid and likely to grow tremendously in the future.

So, I think that it's easier for most of us to stick with value investing, where we can pick up stable companies that are selling at a steep discount to their intrinsic value. In my opinion, it's easier to pick stable companies that would deliver good returns that the needle in the haystack that would outperform the market by a large margin. But I guess that's just the different between the "enterprising" and "defensive" investor introduced by Benjamin Graham in his Intelligent Investor book. Maybe growth investing is a good strategy to be adopted by fund managers, but for the rest of us retail investors, I think it would be more worthwhile for us to stick with value investing to help grow our money.

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  1. Hi

    Some value investing prospect companies that are trading at current P/E of 30x as long as they are confident that the intrinsic value, either based on future cashflow or other method, will be higher than what they are currently at right now.

    They are much more evident in the other overseas market where some of the P/E are ridiculously high.

    1. Hi B,

      That's where growth investing sort of merges with value investing but then the focus on value investing does not really focus as much on growth as growth investing but instead focuses more on safety of the cash flow (hence the constant risk discount present in valuation models). so investing in a company with such a high P/E ratio would make more sense from a growth investing perspective than a value investing one

      Another possible reason for the high P/E is just a poor year for the company, maybe during an industry-wide downturn so it may still make sense to invest in it from a value investing perspective.

      Just Some Thoughts