A number of strategies
guide investors on how to buy shares of companies in the stock market. But two schools of thought which have been highly discussed and deliberated upon are value investing and growth investing. Let us look at each one of them and identify
which is best suited for prospective investors.
Value investing
An interesting and the simplest concept in investment science is value investing. It is nothing new and we have been practicing it for many years as consumers ? buy things cheap.
The idea is to purchase the shares below their actual worth and wait for that value to be recognised by other investors in the market. Value investors normally look at the intrinsic value of the share and its actual value and compare it with the value that investors have given in the market. Intrinsic value is the value of the business including its assets, earnings and dividends. This may be different significantly from the prevailing market price.
In other words, value investors love to bargain trade. Value investors identify stocks that are low priced owing to company?s temporary difficulty, or its industry?s having gone out of favour or even a bear market and buy.
Value investors normally look back like historians and examine the financial statements of the company over the years and identify whether the current share price is lower than the company?s current market price.
Growth investing
Under this style, investors look for companies with the best prospects for above-average growth. They believe that buying companies whose earnings are growing faster than the economy is the best way to a get good rate of return. Growth investors normally believe that a company?s share price has not yet reached its peak and still has potential for rapid growth, then they will buy those shares hoping to sell at a later date at a much higher price.
Under this approach, investors assume that the stock price and company?s growth are directly correlated. Many such companies are normally found in younger industries as they have less history and are subject to rapid change.
What about risk?
Although both value and growth investing are fundamentally a bet on low expectations, value investors tend to be more sensitive to risk than growth investors.
Generally, value investors tend to be very sensitive to capital preservation and aim at absolute returns.
On the other hand, growth investors tend to be very sensitive to changes in growth rates and aim to deliver superior relative performance. As such, growth investors constantly bet on their estimates of future growth rates and profitability of individual companies
and are relatively quick to abandon companies that fail to deliver consistent financial performance.
Which style of investing is better?
Both styles of investing have their own advocates. Literature in this area states that neither strategy is better than the other and each school of thought has its own legions of staunch, single-minded supporters. Which style is more appealing probably depends on investors? tolerance for risk and the length of their investment horizon. The most pragmatic response is probably to subscribe to both styles, which alternate in favour in conjunction with market cycles. So, invest in a blended style, which combines elements of both value and growth.
The writer is an associate professor in finance and
accounting at IIM, Shillong
