Picking up stocks in markets can be defined as more of an art than a science. The markets never move in a straight line and thus investors have to deploy different strategies for generating returns on their investments.
Value investing and growth investing are the best-known approaches that fundamental investing entails. Each type has a loyal set of followers with their own logic, belief system and analysis to back their claims. In this article, let’s see what these approaches are and their suitability.
Understanding growth investing
Growth Investing is an approach in which the investors expect the particular growth companies to grow at a faster clip than others. The investors expect continuous and strong growth in profit, revenues, book value and cash flows. Growth stocks can be found in small-mid and large cap sectors. These companies are fundamentally and financially sound and outpace competitors with innovative product offerings and pricing strategy
Growth stocks have a healthy earnings record and are generally considered to continue with the same in the future as well. Their future growth prospects attract potential investors. These stocks have a higher ‘price to earning’ multiple and are thus considered to be ‘expensive’ when compared with other stocks from the peer group and the overall market as well. Growth companies are still evolving and hence may not have a long history of substantial earnings. However, they display immense earning potential over the future. While they do possess potential, it is important to note that they are also considered to be more volatile and sensitive to price fluctuations based on market sentiments and negative news.
Understanding value investing
Value Investing encompasses an approach that tries to identify value in companies that are currently beaten down, undervalued and are displaying slow growth, but the fundamentals remain strong. The premise of value investing is that the market will recognise the true value of such companies with time and then the price will ‘catch up’ resulting in substantial profits.
Value stocks are generally priced lower than their peers and also in comparison to their performance metrics. They might have a long track record but are currently trading at lower valuations due to certain factors like adverse macro environment or cyclical nature of the business. Value stocks exhibit lesser price fluctuations. This is true during both market highs as well lows. They also have a lower price to earnings ratio. The share price is lower in comparison to its sales, revenue and profitability. Thus they are treated as underpriced.
How do they differ?
Growth stocks seem to be overpriced at given valuations but investors are willing to pay higher prices owing to greater. Value stocks, on the other hand, look cheap today compared to their revenues and earnings. Value investors are willing to wait till the stocks reach their ‘real potential’ but sometimes this wait can be very long. Growth stocks mostly have a proven track record of year on year of consistently high growth and are thus preferred by investors.
Growth stocks come with higher risk due to supposedly higher valuations and greater price fluctuations during times of market volatility. Any negative news can result in a huge slide in share price.
Value stocks, on the other hand, move slowly, do not go up or down drastically and are thus considered to be relatively ‘less risky’. They have a good dividend payment track record and thus are used by investors as a hedge during times of poor market performance. Though dividend is not an essential feature which separates the two investment styles, growth stocks more often than not reinvest their profits for business expansion instead of giving them out as dividends.
Which approach is the best or is it the middle path?
Investing is individual-centric and is based on the investor’s risk appetite, financial goals, time horizon and so on. Although proponents of both these theories have their reasons for liking or disliking a particular set of stocks, there is no ‘right’ or ‘wrong’ approach when it comes to selecting stocks. An investor can have a basket of stocks, from both growth and value universe. Although investors who have spent considerable time in the markets tend to have a style and approach of their own. Still, they always try to create a portfolio of stocks which gives reasonable earning and growth visibility and at the same time is flexible. So while building your portfolio, make sure you are clear about the pros and cons of growth and value stocks and know thoroughly well about the business you are getting into.
Harsh Jain is COO and Co-founder of Groww .
