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Investing comes in many styles. Over the last 12 years since the 2008-9 Financial Crash, the “growth investing” style has gained popularity amongst both retail and institutional investors – with many willing to pay almost any price, it seems, for a stock that they love. Another style, however, argues that investments such as stocks should be analysed to find out their “intrinsic value”, so you can pay a fair price for them.
This “value investing” approach is now starting to gain more media attention as some analysts worry about the high valuations of stock markets. In this article, our team at Hanson Financial Services (financial advice in Liverpool) explores the differences between these two investing styles and whether one offers more benefits over the other.
We hope you find this content useful and invite you to get in touch if you’d like to discuss your own mortgage or financial plan with us.
Growth and value
What would you be willing to pay to gain £1 each year over, say, the next 10 years? Some may be willing to pay £7, for example, whilst others might want a higher return – only willing to pay £3. Essentially, this is what investing is about. You are trying to decide what you are prepared to pay, now, for the present value of all future cash flows.
Imagine, however, that an investment may not return anything for the first three years. However, from year four, you are told that the returns could compound from £3, then to £6 in year five, then £12 in year six – and so on. This starts to get at the idea of growth investing. A company stock may not be turning a profit right now, but if it has the potential to grow in the future then it could be worth the investment.
Value investing, conversely, is more “conservative” in that it tends to look at a company’s past track record rather than resting on assurances of future growth. If, for instance, an investment has consistently paid £1 a year to investors over the past 10 years, then it is likely to continue doing so in the future. At this point, the value investor can decide what she is willing to pay for that £1 annual profit going forwards. Most are likely to seek a “margin of safety” to try and buy the investment at a discount, so they still have a chance of making money if things go wrong.
Is growth or value superior?
Growth stocks are often seen to have the potential to outperform the wider market due to their capacity to scale rapidly. Over the last 5 years, for instance, the S&P 500 has returned 112.55% whilst Amazon has returned 373.63%. Comparing growth and value stocks is difficult, however, partly because not everyone agrees which ones fall into which category. Also, the results will vary depending on the stocks you compare, as well as the time period and market in question.
For instance, some people define value stocks as “usually large, well-established companies that are trading below the price that analysts feel the stock is worth”. Yet many value investors would avoid larger companies like these since they have little room left to grow. In other words, they are still interested in growth – they just don’t want to overpay for it.
Both growth investing and value investors can make mistakes unique to their investing style. A growth investor may get caught up in the “hype” of an exciting growth stock – putting money into it after much of the growth has already happened. A value investor, however, runs the risk of falling into “value traps” – that is, paying for stocks which appear to be trading at a discount, but are doing so for a reason (e.g. the company has high debt and is at risk of default).
With all this said, which approach is better? It partly depends on your investment horizon and goals. If you are a young investor who has decades ahead to allow for capital growth, then you might be prepared to invest in more growth stocks. If, however, you are nearing retirement and want to preserve much of the capital you have built up – perhaps taking some dividends over the years ahead – then your portfolio might lean more towards value stocks.
The data on value versus growth investing is currently inconclusive. One study by John Dowdee examined market performance from July 2000 until 2013, and found that value stocks did better than growth stocks on a “risk-adjusted basis” amongst small, medium and large-cap stocks. Yet he was forced to conclude that what truly matters is the time period concerned, since from 2007 to 2013 growth outperformed value. Another study by Craig Israelsen in 2015 looked at stocks from 1990 to the end of 2014, and came to a similar conclusion – with a slight edge for value.
Conclusion & invitation
Are you interested in talking to a financial adviser about your financial planning needs? We’d love to assist you here at Hanson Financial Services.
Please contact us to arrange a consultation with our team – free and without obligation – to gain more clarity and peace of mind over your financial plan.
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Liverpool Office: 0151 708 7616
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