Value investors are lazy, and need incredible luck to win. Follow Buffett and go for growth.
This article forms part of our Duelling Fools feature on 'value vs growth investing'. Read the case for value investing and then vote in our poll.
I'll keep this simple…
The way to make serious money from the stock market is to invest in superior businesses when they are trading at a fair price.
Got that?
The absolute key is finding superior businesses, and by superior business, I'm talking about companies with long-term sustainable competitive advantages.
Unfortunately, such beasts are few and far between. Over in the US, a company like Microsoft was once considered to be the poster child for competitive advantage. Since March 1986, an investment in Microsoft is up a massive 24,344%. That's what I call growth investing!
Google is another example of a company with a sustainable competitive advantage. Many have tried and all have failed to break their absolute stranglehold on the search market.
Google Was A Value Share
Google has only been a public company for five years, yet in that time, including the huge stock market correction we've just experienced, Google shares are up 330%. Even more impressively, in that same time period, the S&P 500 is flat.
Here is a forgotten fact about Google… when it floated in August 2004, the shares were valued at more than 100 times earnings.
So-called value investors wouldn't have touched Google shares with a barge-pole. But they were wrong. Value investors couldn't see past the end of their nose. Once they see a P/E above something like 12, they go into an apocalyptic fit.
Just Say No To Brown Cardigans
It's best to keep well away from value investors. If you see one in a pub, steer well clear. They'll be able to talk the hind legs off a P/E ratio, and if you get sucked into their spell, you'll soon be drinking stout, wearing brown cardigans, flared trousers and horn-rimmed glasses.
And you'll also soon be closing yourself off from investing in some of the very best companies out there on the stock market.
You see, Google is one of the very best companies in the world. At the time of its float, Google was growing fast, continuing to take market share, and building sustainable competitive advantages in its enterprising culture, superior advertising platform, and brand loyalty.
All any smart investor had to do was look forward a couple of years, look at Google's superior growth rate and its powerful business model, to realise it was under-valued, even at 100 times earnings.
Clap-Trap
I can feel the value investors shouting at the computer screen, screaming "ridiculous", "what clap-trap" and even the odd obscenity at me. They simply cannot and will not accept that you sometimes need to pay up to buy true quality shares.
Value investors would rather spend their time sifting around the dregs of the stock market, looking for a company trading below book value, on a P/E of 2 and a dividend yield of 13%.
There is only one reason the shares would be trading on such a lowly rating -- it's a crap company. I've done crap companies. It's a nerve wracking experience. At any moment, a profit warning is just around the corner. At any moment, that juicy dividend yield of 18% can and does shrink to a big fat 0%. A trailing P/E of 2 can quickly turn to a forward P/E of 85.
These are "cigar-butt" type investments. They were given that name by the doyen of value investors, Benjamin Graham, because you could only get one more puff out of them before they were extinguished.
An Incredibly Risky Strategy
Call me simple, but I think that's an incredibly risky strategy. The success or failure of your investment comes down to timing. You have to watch the shares like a hawk, guessing the best time to buy and the best time to sell. Good luck with that strategy. If you ask me, life's too short. Plus, as all good investors know, you can't time the market.
The value investors will happily quote "all investing is value investing" at growth investors till the stout dribbles down their cardigan. Well guess what? I agree.
What the value investors are missing is the quality of the company. They focus exclusively on the share price. Growth investors focus first on the quality of the company, and secondly on the share price.
Growth investors might be prepared to pay 15 or 20 times earnings to buy shares in a company operating in an attractive industry and which has a sustainable competitive advantage.
Buffett Is A Growth Investor
Even Warren Buffett is a growth investor. One Wall Street analyst called Coca-Cola "very expensive" around the time Buffett started buying it. It wasn't a typical value stock. But as Buffett once said about Coca-Cola: "If you gave me $100 billion and said, take away the soft drink leadership of Coca-Cola in the world, I'd give it back to you and say it can't be done."
You can forget your speculative investments in junk stocks like Avis Europe (LSE: AVE), Trinity Mirror (LSE: TNI) or even Royal Bank of Scotland (LSE: RBS). Sure, you might get lucky and one of them might shoot to the moon. Or you could end up with Raymarine (LSE: RAY), down 86% over the past 12 months, but very cheap, trading on a trailing P/E of 1 and a trailing dividend yield of 18%.
Do you feel lucky?
Give me quality, high margin, recurring revenue, growing shares like Autonomy (LSE: AU), IG Group (LSE: IGG), Admiral Group (LSE: ADM) and Ashmore Group (LSE: ASHM) any day. Buy them when they are trading at a fair price, sleep well, and watch your investment compound higher and higher in the years to come.
The Final Word From The Master Himself
I'll leave the final word to growth investor Warren Buffett, the second richest person in the world. He didn't get to be worth $37 billion by buying shares in crap companies.
"It's far better to buy a wonderful company at a fair price than a fair company at a wonderful price."
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