Value or growth? Investors traditionally adopt one as their naturally applied investment philosophy. While the approaches are at odds with one another, both have merit given certain conditions, but let’s explore how you can refine your investment philosophy to position your portfolio for superior returns in 2020.
Growth at any cost…
The typical growth investor is less worried about valuations, if the growth expectations on offer are attractive enough. Many growth shares will trade at high price-to-earnings (P/E) multiples, incorporating future growth expectations. As a result, growth investors continually must weigh up the downside risk of chasing growth at seemingly punchy valuations and the cost of paying upfront for future growth.
Over the course of 2019, Warhammer founder Games Workshop (LSE:GAW) entered the growth stock category as a high-quality business commanding a premium valuation. Year to date, the business has delivered a total shareholder return of 88% and now trades on a forecast P/E ratio of 24.2 versus a historical 10-year average of 14. Much of the growth is already factored into the existing price, leaving investors with little downside protection.
Is a return to value on the cards?
Value investing is centred around fundamental analysis and securing a bargain price for a sound business. The ‘Sage of Omaha’, Warren Buffett of Berkshire Hathaway is the ultimate champion of value investing. Over the years his approach has been tampered somewhat, as the qualifying criteria becomes harder to apply in the modern economy where intellectual capital is the driving force behind future growth. But I believe as growth stocks begin to fall out of favour, with lofty growth expectations factored into the price, investors will once again return to value.
Adding a dose of reality to punchy valuations…
The key is to be agile enough to use these diverse perspectives to shape our investment thesis. Wouldn’t it be smashing to buy a stock with great growth prospects, at a fair price? Enter the ‘price-to-earnings growth’ ratio (PEG). Jim Slater created this metric to tackle this exact problem. It’s a simple variant of the P/E ratio that takes into consideration the earnings growth prospects of the stock to illustrate its attractiveness.
Strong catalysts put the odds in favour of the house…
As a general rule of thumb, shares with a PEG of less than one and a half present a decent opportunity. Take a look at multi-channel gambling stalwart The Rank Group (LSE:RNK), which currently trades at a PEG of 0.5. The stock possesses some strong catalysts capable of driving an earnings upgrade, with an impressive recently embedded management team focused on acquisitions in the digital space and sensibly trimming the cost base.
Compare this to Games Workshop, trading at a PEG of 2.1. I’m much more comfortable with the risk:reward profile a lower PEG ratio offers. I’m an advocate that a blended philosophy incorporating value and growth means investors don’t have to pay over the odds for growth.
With valuations stretching beyond historical averages and economic growth stagnating, I see a huge opportunity for investors to capitalise on unloved stocks trading at a discount. We might not be able to find traditional ‘moat’ companies at as deep a discount as Mr. Buffett once did, but opportunities such as the Rank Group have merit as we move into 2020.
