Recently I met a cousin of mine, Pranay who asked me, “Should I go for high growth stocks or look for value stocks?’’
His question took me by surprise, given the fact that he had just started investing, but I assume he must have read up about these investing styles somewhere.
It was even more surprising for me because till date, nobody had asked me this important question, not even people I know who have been investing for several decades now.
Nevertheless, I told Pranay what legendary investor Warren Buffet had told the shareholders of Berkshire Hathaway many years ago, “Value and growth are joined at the hip’’.
“What does this mean? Can you explain in detail” he asked with a confused look on his face.
Even as you read this, I am sure you too must be having the same doubt after reading Warren Buffet’s comment.
Well what it means is growth is one of the parameters an investor needs to look at while investing in high value stocks. Irrespective of the fact, whether growth is positive or negative, it is an important factor which should not be ignored.
Before we proceed further, let’s take a look at what exactly growth and value investing approach means.
Growth investing is all about looking for companies that have a potential to grow faster than others. Such stocks have low dividend yields and higher price-to-earning (P/E) ratio and price-to-book value (P/B) ratio.
Growth stocks generally tend to perform better when interest rates are falling and company earnings are rising. However, they are the first to fall during economic downturns.
On the contrast, value investing is all about buying undervalued stocks for a market price below its intrinsic value. Such stocks have above-average dividend yields and low (P/E) ratio.
Value stocks, generally do well early in an economic recovery phase but appreciate slowly during a sustained bull market phase.
Most investors feel that ‘Value’ and ‘Growth’ belong to two opposite styles of investing. In fact in his letter to his company’s shareholders, Warren Buffet himself admitted that he too used to think on the same lines previously, but realized that it is not the case.
Here’s an excerpt from Warren Buffet’s letter:
“Common yardsticks such as dividend yield, the ratio of price to earnings or to book value, and even growth rates have nothing to do with valuation, except to the extent they provide clues to the amount and timing of cash flows into and from the business. Market commentators and investment managers who glibly refer to “growth” and “value” styles as contrasting approaches to investment are displaying their ignorance, not their sophistication. Growth is simply a component – usually a plus, sometimes a minus – in the value equation.”
In simple words, the phrase ‘Value and growth are joined at the hip’ means that growth and value are closely connected. Instead of looking at growth and value as separate fundamental approaches, an investor should look at growth as a component of value, while investing.