Are you a value investor or a growth investor?
I reckon that’s a silly question because ‘value’ implies growth and successful growth investing requires finding good value.
Value
What’s value when it comes to shares? A quick answer might be, a low share price compared to the firm’s earnings, assets or cash flow, or all of those things. However, on their own, such low metrics don’t indicate value at all, they indicate cheapness.
The ‘grandfather’ of value investing Benjamin Graham published his ideas in the classic book The Intelligent Investor, which was published in 1949. Graham argued that a margin of safety is necessary when buying shares because we can’t predict the future performance of the underlying businesses.
For a while, through the 1950s mainly, Graham and his disciples such as Warren Buffett, made a packet buying cheap shares. Then when they re-rated upwards, they would sell, fast, to prevent the potential poor underlying economics of the businesses taking their investments down again.
Deep-value investing like that became so popular that it stopped working very well. Benjamin Graham declared the strategy dead some years after writing his book. In the end, investors found that good companies rarely sold at bargain prices. Often, companies selling dirt-cheap tend to deserve it now, so deep-value investing carries a lot of risk.
Buying a company too cheaply can mean we don’t end up with good value at all. Instead, we might get a long shot, one with such bad prospects that the firm needs a complete turnaround to deliver a return on our investment.
Growth
If buying cheap shares is risky, how about buying shares of firms with strong yearly growth in earnings instead? It’s tempting to hop aboard an earnings uptrend in a fast-growing company and hope that momentum in the share price will stay in uptrend too.
Growth investing is so popular today, that firms with high rates of growth rarely sell cheaply. The risk of buying shares at high valuation multiples is that the slightest piece of bad, or even lacklustre, news can send the share price tumbling as the market recalibrates its expectations for the business. Paying high prices for fast-growing firms can be dangerous.
Best of both
To find good value, I think it best to first focus on looking for good quality. A strong trading niche can often deliver high returns on capital and equity, high rates of earnings growth and juicy profit margins. I look for those.
Good value to me means getting such great firms in my portfolio at fair prices. They’ll never be dirt cheap, but I’m looking for ‘value’, not ‘cheap’. That often means buying the glitches in a shares uptrend — those times when a growing, quality company sees its share price temporarily knocked by a setback of some kind. It’s a great way of applying value to growth and helps avoid the pitfall of buying companies that are cheap for a reason or paying too much for growth.
Value and growth are closely linked. You can’t really have one without the other because growth is what makes value valuable and value is what builds when a firm is growing. Applying a value mindset to the purchase of growing businesses with good prospects is a well-trodden route to winning on the stock market.
