Today, we are going to look at the two main investment styles, along with their pros and cons.

Most individual investors (or funds) stick to one or other style of investing. When the market is in their favour, they evangelise their style of investing as being the best one. But when the market turns, other styles outperform. It is important to know the different styles of investing so that you know what you are getting into.

Most people don’t understand the characteristics of the investments they own and are disappointed with the results.

Let’s dive in and look at:

• Value investing

• Growth investing

Value investing

At its core, value investing is a strategy that involves picking stocks which are trading at less than their intrinsic value. Intuitively, buying stocks for less than they’re worth makes sense. But that is easier said than done.

Value investors are looking for stocks with the following characteristics:

• Low price-to-earnings ratio.

• Low price-to-book ratio.

• High dividend yield.

• A discount relative to peers or the market.

Usually good companies that are doing well, don’t have these characteristics. So in order to implement a value investing strategy, something has to be wrong.

A value investor will be looking for a good company that has hit on some temporary hardship, which can be resolved in future. The market will price in too much bad news and the company’s stock will be a bargain. The investor buys it and waits for the problem to resolve itself. At that time the stock will reprice and the investor will be in the money. An example of this could be a food company that has a quality scare. Investors will run for the hills, but management can solve the problem and the company will get back on track.

Another way of finding value companies is to look at great companies in countries where sentiment is negative. Their entire market will be priced lower, including the great companies. You can pick these up at a bargain.

Value investing also comes with it’s dangers. The main one being value traps. These are companies which appear to be cheap, but when you buy them, but they remain cheap indefinitely. Normally, these companies have been priced lower because they have persistent difficulties. Unfortunately, you probably invested without recognising the problems.

Value investing is a strategy that does well when markets are overpriced and falling. The discount at which you have purchased your stock acts as a buffer. In general, value investing makes sense. There is a lot of uncertainty in valuing a company, so it is prudent to purchase at a discount in any market.

Growth investing

The other major style of investing is called growth investing. Growth investors aim to purchase stock in companies where earnings are growing at an above-average rate. If the stock price keeps pace, the investor’s returns will also grow an above-average rate.

Growth investors are looking for stocks with the following characteristics:

• High earnings per share growth.

• High price-to-earnings ratio.

• No dividends – because money is being reinvested for growth.

Typically, growth investors are looking for companies in industries which are growing at a fast pace. Clearly, the internet and technology companies met this criteria in the recent past.  Examples of growth stocks include companies like Google, Facebook (Meta) and Amazon, which grew at incredible rates over the past two decades.

One of the challenges of growth investing is finding a company that is going to make it big. For example, Yahoo also played in the internet search sector but lost out to Google. MySpace was a social media website but it lost out to Facebook. These companies were growth bombs – they grew at a high rate for a while, but that growth petered out.

Growth investing is a strategy that does well when there is a nascent industry, like the internet was (and is). Seven of the ten largest companies in the world currently are technology companies. Most of them were small or did not exist 20 years ago. Clearly, growth investing can be very profitable.

Conclusion

As an investor, it is important to know what you are getting into. If not, you will be disappointed by the results. The next time a fund manager is evangelising his investment style think about it and consider whether they can repeat the performance.

Growth and value are the main investment styles. Almost every other style of investing you will hear about is a variant of these two styles. For instance, contrarian investing is a variant of value investing. Quality investing is a variant of growth investing. And dividend investing has characteristics of both styles. We will look at some of these in future. 

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