Investing For Value Or Growth. What Is Right?
Value or Growth, what type of investor are you?
During the 1920s, Benjamin Graham, a renowned professor and investor, established a new wave of investors at Columbia Business School, solidifying what we now recognize as Value Investing.
After reading The Intelligent Investor, Warren Buffett actively sought out Benjamin Graham, greatly influenced by him and subsequently developing his own investment style known as ‘cigar butt’ investing.
Warren Buffett’s ‘cigar butt’ strategy involved locating distressed companies trading well below their net assets and patiently waiting for their share price to reflect their underlying value before selling.
Similar to a discarded cigar butt that still holds a final puff, such opportunities to capitalize on have become increasingly scarce.
In contrast, Thomas Rowe Price Jr., often referred to as the father of growth investing, launched the T.Rowe Price Growth Stock Fund in 1950, just a year prior to Buffett approaching Graham.
Growth investing focuses on identifying companies expected to expand rapidly, surpassing the average growth rate of their peers or the broader market. Typically, these companies are younger and smaller, with the potential for substantial future profitability.
If asked to choose between value and growth, I cannot provide a definitive answer, as they are two interconnected aspects. Value and growth are inseparable; one cannot exist without the other. Growth always plays a role in determining value. Intelligent investing encompasses both growth and value.
Investing for Value but Not Growth
Value investing offers a prudent approach to discover stocks trading at discounted values relative to their company’s assets.
This typically entails seeking out companies with low valuation multiples, such as P/E ratios or share price multiples to book value, sales, or cash flow.
However, it’s important to acknowledge that companies trading at attractive valuation multiples may have underlying reasons for such levels, which aren’t always positive.
Lower valuations often indicate businesses that have fallen out of favor with investors or possess uncertain prospects for generating high returns.
Unfortunately, individual investors like us lack such opportunities and the ability to persuade company boards to sell assets and distribute them to shareholders.
Unlike Warren Buffett, who had access to substantial investor funds, that enabled him to acquire minority stake in companies, and secure a seat on their boards.
Buffett’s advantage lay in influencing board decisions regarding asset sales or business wind-downs, thereby enabling him to generate returns.
The rationale behind purchasing undervalued shares lies in capitalizing on the disparity between net assets and the current share price.
However, this strategy only works if management demonstrates foresight and prioritizes the interests of shareholders.
In many cases, managers may persist in running the business until there are no remaining assets to distribute to shareholders, regardless of the price paid for the shares.
Consequently, if management continues to erode shareholder value, the price paid for the shares becomes inconsequential.
Investing for Growth but Not Value
Growth investing has become the favored choice, alluring with its novelty and the promise of spectacular returns. This is particularly true in times of low interest rates.
Like zealous fans, investors chase after growth stocks, driven by their compelling narratives and bright prospects, hoping to ride them to the moon, but sometimes witnessing a crashing descent back to reality.
Many of these “growth stocks” lack earnings, revenue, and display astonishing cash burn, yet command eye-watering valuations, aligning with the “high risk – high rewards” mentality.
Consider this scenario: an ASX listed company reported revenues of USD$120k and a net loss of USD$22 million in 2020. Without knowing their narrative, what would you be willing to pay for it?
At that time, the company held a valuation of $2.5 billion. While their growth potential may eventually align with that valuation, the current share price reflects excessively optimistic expectations. This leaves little margin for error that might disappoint investors.
What happens when forecasts fail to meet expectations and interest rates begin to rise? In the case of the aforementioned company, it suffered a 75% decline in value since then.
This isn’t to suggest that the previous price was too high and it is now undervalued. In an alternate reality, the company could have continued to soar.
However, it highlights the importance of relying on fundamentals and evidence rather than relying solely on narratives. Otherwise, the anticipated growth may turn out to be mere illusionary fairy dust.
Before embracing a narrative, let us consider the wisdom of Charlie Munger, Warren Buffett’s trusted associate:
“No matter how wonderful a business is, it’s not worth an infinite price.”
-Charlie Munger-
Investing for Value and Growth
Let us delve into the essence of value and growth. Can value truly exist without the ability to generate earnings and cash flow, even at low prices?
Similarly, what is growth without a meaningful capacity to generate positive cash flow and future earnings at a reasonable cost?
The answer is simple: a bad investment.
Intelligent investing encompasses both value and growth, as these two concepts are intrinsically linked. They cannot exist independently of each other.
To achieve long-term value creation, we must seek out exceptional businesses with the potential for sustained growth, while ensuring they are reasonably priced.
Value investing, on its own, may have been effective half a century ago. However, in today’s digital age, such opportunities have become scarce.
This is due to the inherent efficiency of the stock market, where share prices generally reflect the underlying value of stocks. There are no free lunches.
Nevertheless, there are occasions when a disconnect arises between price and value, influenced by investor or market sentiment.
A company may trade at a P/E ratio of 100 and still be considered cheap, while another company with a P/E ratio of 10 could be seen as expensive. The former might achieve a 25% annual earnings growth and have a P/E ratio of 30 in five years, while the latter could experience negative earnings growth and end up with a P/E ratio of 50.
As investors, it is our responsibility to discern which companies will sustain growth over the years and acquire their shares at reasonable prices.
This is where growth and value converge. They are inseparable, and we cannot pursue one without acknowledging the importance of the other.
Key Takeaways
- Value investing by itself will not guarantee a safe and great investment
- Growth investing by itself will not guarantee a superb and out-performing investment
- Value and growth investing together will increase your chances of value creation
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