Growth vs value – which is best?
We take a look at the difference between growth and value investing, and share our view on what investors should consider.
When it comes to investing, there's a lot of jargon out there. The terms 'growth' and 'value' are thrown around a lot, but what exactly do they mean? And is one better than the other? What other investing styles are there?
In simple terms, growth investors tend to look for quality companies with strong earnings growth potential. While value investors seek lowly-valued companies that might have fallen on hard times, but where the investor sees improvement on the horizon.
It's worth considering what each style of investing aims to achieve. Ultimately, all long-term investors, whether focused on growth or value, aim to achieve the best-possible returns within their investment universe. The difference is in the approach they take and the type of company or asset they seek.
Value and growth are mainly used in relation to investing in equities (company shares). Here we take a closer look at some of the differences between these investment styles.
This article isn't personal advice. If you're not sure what's right for your circumstances, please seek financial advice. All investments fall as well as rise in value, so you could get back less than you invest.
As the name suggests, growth companies are expected to grow faster than others. Fund managers, or investors, using this style tend to seek companies they believe will deliver above-average growth as measured by factors such as earnings, revenues, or cash flow.
Some companies are expected to grow earnings at a more predictable rate. Others might be loss-making or make little profit right now, but are expected to develop rapidly in future. In the end, the belief is that a company that can grow its earnings rapidly could see its share price rise faster than the average.
Growth-orientated companies are typically less likely to pay dividends to shareholders. Instead, they often focus on reinvesting profits back into the business or on expanding by making lucrative acquisitions. Technology companies can be an example of this, as they're often growing quickly and need capital to do so, or to continue to invest in research and development.
Growth investors are often seen to invest in some of the world's most exciting companies. That said, if they don't meet investor expectations, or fail to achieve what they set out to do, their share prices could fall. They can also face headwinds in the form of higher interest rates and inflation as this can erode the value of expected future cash flows and earnings.
What about value investing?
Value investors seek companies that are often seen to be less glamorous.
The basic premise is their shares can be bought at a price which isn't reflected in the company's future earnings potential, or what the investor believes is their true worth. In other words, they are 'cheap' or at a discount to what the true share price should be.
Why might a company's shares not reflect its true value? These businesses have often fallen out of favour or been ignored by other investors. This might be because they've missed a profit target, or the management team have made some unpopular decisions. Or they might be part of an industry that's currently unloved. Alternatively, they might simply be misunderstood.
Either way, a value investor must believe the share price has a chance to recover. To do so, the prospects of the business might simply need to be recognised by more investors. Or it might need to show that it's undergoing change, improvement, or a recovery. The all-important goal is to invest in those businesses whose prospects for the future are brighter than commonly believed.
Rummaging around in the bargain basement for hidden value can be risky. Some investments could be 'value traps' – firms in terminal decline or destined to go bust. It's important for investors to try to avoid those that are past the point of no return.
Investment styles come in and out of favour. As a result, you'll often find that when growth investing is in vogue, value investing doesn't perform as well, while the reverse is also true.
Other investment styles
Growth at a reasonable price
With thousands of investors across the globe using their own investment style, it's not always so simple to pigeonhole them into the growth or value camp.
Some investors use what they call a GARP (Growth at a Reasonable Price) investment strategy, which includes parts of both growth and value investing. GARP investors tend to seek companies demonstrating consistent earnings growth, which aren't trading on unreasonably high valuations.
Blended or defensive
Other managers use a more blended strategy, which might mean they invest in both growth and value stocks, or in companies that don't so obviously fit these categories. Some managers might invest differently throughout a market cycle, tilting their portfolios towards different types of stock depending on where we are in the business or economic cycle.
There are also funds that focus on companies or sectors that are expected to hold up relatively well when markets or the economy go through a tough patch. These might be described as 'defensive' or 'conservative' and hold up better than others when the market falls, but lag a rapidly rising market.
These funds have the potential to perform well in various market conditions or be less volatile than funds with a more obvious style tilt, though there are no guarantees for how these funds will perform.
Some funds have a specific aim to produce a regular income for investors.
Managers of income funds focus on companies that pay a dividend to shareholders. This means they're less likely to invest in growth sectors, due to the limited dividends on offer, and might invest more in value. That said, even income investors can use different styles, and won't always have a significant bias towards value.
Which style is best?
Every investor has their own preferences. They'll also have their own personal objectives and attitude to risk. That's the starting point for all investors and will help them determine what to invest in.
In our view, it makes sense for a long-term investment portfolio to have exposure to a variety of investment strategies. Growth and value stocks will perform differently and at different times – there have historically been prolonged periods when the two investment styles have moved in and out of favour.
Within a diversified portfolio that invests with managers with varying styles, the hope is that at least one investment is performing well, or better, at any one time. Combining different approaches also has the potential to help reduce volatility and improve long-term performance potential.
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