The two most commonly cited styles of investing are value and growth. Both of these styles have their own separate advantages and drawbacks, but what are the key differences between to two?
Value vs. growth
Before I get into what separates these two styles, I want to outline the one connecting factor between value and growth: Fundamental analysis.
Value investing and growth investing are different styles, but are connected by the fact that they both require rigorous fundamental analysis to be successful.
Growth investors want to know where the growth is going to come from and what advantages the company has over the rest of the market that will enable it to achieve this growth. Meanwhile, value investors want to understand why the company they’re looking at is cheap, what has gone wrong, what could go right and how much risk there is in the business.
In many ways, growth investing is far more time intensive than value investing because it requires a broad knowledge and understanding not just of the company under consideration, but also the rest of the industry.
Defining the styles
Broadly speaking, value stocks are stocks trading at low valuations while growth stocks tend to command higher valuations, which is usually justified by rapid earnings growth.
This is a very broad definition. If a company is forecast to grow earnings rapidly, but due to some quirk of the market is trading at a low valuation, it is difficult to place it in either bucket. In other words, it is possible to be both a growth and value investor.
Value investors tend to invest in cash flows rather than future growth potential. Growth investors might be content owning stock in a company that has not, and is unlikely to, report a profit for some time, but value investors would avoid such a situation.
Put simply, value investors want to invest in companies where they are able to compute a rough estimate of intrinsic value and buy at a deep discount to this value to limit the risk of investing.
Meanwhile, growth investors tend to be more open to investing in businesses that have not yet reached their full potential, and are happier to pay more today, for the prospect of greater rewards in the future.
Which investor are you?
Which style you choose to follow in your investing career really depends on your personality. Growth investing can be unpredictable and requires a lot of work to stay ahead of the market.
Growth stocks tend to be volatile because high valuations leave little room for error. If they miss growth projections, the market’s reaction can be brutal. It’s not uncommon for a growth stock to lose more than 20% of its value in a single trading session after missing growth forecasts.
Value stocks tend to come with the less volatility and there are less moving parts. However, they do require much more patience.