One of the most passionate but unresolved debates in the investment world is whether so-called growth stocks or value stocks offer a better return. Even though the ultimate objective is the same –to make money– the statistics get twisted and opinion is polarized when trying to discern the best route to take.
“Value investing is the premise that you can buy a dollar’s worth of assets for 70 cents,” says Scott Schermerhorn, president of Granite Investment Advisors and manager of the Granite Value Fund in the attached video. He says the chance to buy companies on sale typically comes when nobody else likes them or they have been beaten up due to some sort of mishap or controversy.
On the flip side, Schermerhorn says that “Growth investing is where you believe that you can buy something that will grow faster than the market over a period of time.”
Growth investing is often done before the actual growth shows up or accelerates. This ”crystal ball” or anticipatory facet is arguably the most difficult aspect of choosing a growth stock, and perhaps the most risky too. As Schermerhorn explains, if you are wrong about the growth, “all you have is a very expensive company.”
Speaking of expensive, another key area of difference between the two styles is the notion of cheapness when acquiring stocks that fit the criteria of the latter.
According to Schermerhorn, a value stock will normally be trading at a discount to the broader market by at least one of three common measures or ratios: Price to Earnings, Price to Book Value, or Price to Cash Flow. But be careful because even when a stock has one of these particular low valuations, he warns that it could be the result of market or economic conditions and that further analysis is needed. In short, a low P/E ratio, in and of itself, does not a value stock make.
“What people need to understand is the difference between a good company and a good investment,” he says. “Is Facebook a good company? Yes. Is it a good investment? That remains to be seen.”
Sticking with the Facebook example, when the company filed its papers to go public last month, analysts projected it could be worth as much as $100 billion, even though it earned only $1 billion in profit last year. Clearly investors are excited by the opportunities that the social media giant has to offer, and they are willing to pay up for it.
Compare that to putting your hard earned money into a beaten up, lagging, or otherwise unsexy stock that has just fallen 0ut of bed or is going nowhere. While Schermerhorm admits that growth companies tend to be “more popular and more comfortable” for people to own, he also says there are advantages to investing in value stocks too.
“If you’re a value investor, at the end of the day if you’re wrong, chances are you’ve got a good bit of valuation support so that you shouldn’t have too much downside,” he explains. “Whereas on growth, if you’re wrong you’ve got a good bit of downside.”
The bottom line is a strong case can be made for owning both types of stocks and that the tipping point on whether you choose one style or the other is nuanced and as much about comfort, time frame and suitability as it is about hard, fast rules.