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Broadly speaking, there are two main types of equity investing – growth and value investing. Yet what are the differences between them? Do these matter, and why are some people saying that the latter is “making a comeback”? In this article, we explore these questions in more detail for our financial planning clients and readers at Cedar House.
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Growth & value
To grasp the differences between growth and value investing, it is important to understand the idea of valuation. In other words, how much do you believe a stock (or fund) is worth now – and in the future? Moreover, what should you be willing to pay for it when you invest?
Growth investors will typically focus on the potential of the company/stock to grow its revenues, earnings per share (EPS), cash flows or other value-generating metrics in the future. If they think that this potential is very high then this can justify paying a high price for the investment now – even paying far above what it is “currently worth”.
Many people point to Tesla as a current example. At the time of writing, Tesla’s market cap is $1.14tn and it’s share price is $1,136.99. Ford, by comparison, has a market cap of $78.61bn and is going for $19.67 per share. Right now, the stock market clearly expects bigger things from Tesla than it does from Ford and is willing to pay more for this growth potential.
Value investors, however, focus more on finding companies with strong financials which the market does not recognise (i.e. the share price is lower than it should be). By buying these stocks “at a discount”, therefore, a value investor can then wait until the market recognises the “intrinsic value” of the stock. At which point, the share price should (hopefully) rise and the value investor can sell his/her shares for a big profit.
The growth era
Since the 2008-9 Financial Crisis, we have arguably seen a surge in popularity for growth investing in the western world as a 11+ year “bull run” sent stock markets soaring (interrupted only in a big way by COVID-19 in 2020, but was followed by recovery). Today, many analyses suggest that stock markets – particularly in the US – are now “overvalued”, meaning that share prices now, largely, far exceed intrinsic values. In 2021, it seems that many investors are very optimistic about stock markets continuing to grow and do not mind paying a high price for it.
However, there are signs that value investing may be becoming more mainstream as investors worry whether this trajectory can be sustained. Indeed, there is even evidence that value may be starting to compete with growth. Between mid-October 2020 and January 2021, for instance, the MSCI World Value Index rose 16% – more than the 11% achieved by its growth stock benchmark. The question, of course, is why is value starting to gain popularity – and how should it feature in your investment strategy (if at all)?
Growth vs. value
It is difficult to determine which approach is better for investors – partly because definitions vary. People class “growth stocks/funds” and “value” ones differently. Additionally, the time period in question matters hugely. Over the last ten years, there has been a huge “Drought in value – the longest on record”, as put by Ted Aronson – a widely recognised value investor. However, many investors now believe that value is set to do better than growth in the years ahead (according to one study by the Bank of America).
Here, it is crucial that investors recognise that the uncertainty around equity investments makes it necessary to diversify properly – and to invest in line with your risk tolerance. For instance, it may be that value outperforms growth in 2022 and beyond. Or, perhaps the opposite turns out to be true. By including an appropriate mix of “value” and “growth” stocks in your portfolio, you can still aim to grow/preserve your investments in the event of either outcome transpiring. This also means spreading your investments across multiple countries, markets and company sizes rather than concentrating too much in one area.
Another important factor is to check the financial health of the companies and funds you want to invest in. If the underlying fundamentals of your investments are weak (e.g. there are too many illiquid assets in a fund), then this can put capital at unnecessary risk. Here, a financial adviser can help you sift through different options on the marketplace and construct a portfolio that you feel confident in, over the long term. Finally, make sure you take your investment horizon and financial goals into account when deciding upon your investments. A shorter period of investing, for instance, can make it necessary to “de-risk” a portfolio as you approach the withdrawal date.
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