Since the time investing became a widespread pursuit, people have found themselves cornered by the question of whether to opt for value investing or growth stocks. As an investor, you may find both the ideas appealing – it is as rewarding to invest in fundamentally strong stocks which are currently undervalued, as it is to park your funds in companies which are growing faster than the market.
Both these strategies offer tremendous potential for returns and have proven proponents. While Warren Buffett and Prem Watsa are extremely famous value investment gurus, growth investment also has its fair share of legends such as Michael Burry and Pat Dorsey.
The question then arises – are these two styles actually opposites of each other or are they just two sides of the same coin?
Growth and value equation
As equally popular strategies for identifying stocks with the potential for strong returns, growth and value investing have different approaches to identifying promising investments, and together, they have the ability to power a winsome portfolio. First, let us understand the core of these strategies as this will enable us to achieve synergy between the two.
Growth companies typically reinvest their earnings into the business to fund expansion and development of new products or services and growth investors are willing to pay a premium for these companies because they believe that the potential for future earnings growth justifies the higher price. Growth stocks tend to have high price-to-earnings ratios, reflecting the market's expectation of future earnings growth.
Value investing, on the other hand, seeks out companies that are undervalued by the market, and plagued by lower earnings growth rates or temporary challenges which have caused their stock prices to decline. Value investors are of the opinion that the market has overreacted to these challenges, and that the company's true value is greater than the current stock price, making it a great buy. Value stocks tend to have lower price-to-earnings ratios and higher dividend yields, reflecting their lower price and potential for future price appreciation.
Attaining optimal synergy
While growth and value investing are often thought of as distinct strategies, there is actually considerable overlap between them, with the price factor playing a very important role in this relationship. Many growth stocks also have value characteristics, such as a low price-to-earnings ratio relative to their growth rate. Similarly, value stocks may have growth potential that is being overlooked by the market.
As an investor, you may choose to focus on one strategy or the other, depending on your market outlook and investor profile but, if you do not have a definitive way forward, combining them in a single portfolio can trigger stellar returns.
The choice will depend on your risk tolerance, investment objectives, and the underlying market conditions because, usually, growth stocks tend to perform well in bull markets when investors are optimistic about the economy and corporate earnings.
Alternatively, value stocks tend to perform well in bear markets, when investors are more risk-averse and seek out stable, income-producing investments. With a well-rounded portfolio featuring both these strategies, you stand to minimise risk and optimise returns in one fell swoop.
Mr. Raghvendra Nath, Managing Director of Ladderup Wealth Management