By Howie Bick – https://theanalysthandbook.com/
When it comes to investing, there are lots of things to consider in deciding on the type of investments you choose, the type of strategies you deploy, and the type of philosophies you embody. Two of the more commonly practiced investment philosophies are value investing and growth investing. Value Investing is all about finding mispriced or undervalued investments relative to their market values. Growth Investing on the other hand, is about looking for companies who are poised to grow, whether it’s through increased market share, industry expansion, operational excellence, or any other way to grow their business. When you’re analyzing the different the companies or investments available, there are a variety of things to consider when it comes to both value investing and growth investing.
Whether it’s due to a poor sentiment surrounding a company, any changes or events that may affect a company, or the market not understanding its true value, value investing tries to locate those inefficiencies and take advantage of it. Many investors look to analyze a company’s financials, understand it’s underlying business, and try to determine a fair market value for the company. Comparing the market value you’ve come up with or created, to the current trading price or value the markets’ put on the company, is where you can determine if there’s any value to be had. Seeing if there’s any discrepancy or difference between the two, you can determine whether you’ve uncovered or discovered any underlying value.
The way an investor approaches a value investment or tries to use a value investing philosophy is also important to consider. When trying to take a value investing approach, the cash flows returned or generated by the company or investment are very important. Without having the cash flows, or the future cash flows, it’s very difficult for the company or investment to generate any true value. That’s why, the security of those cash flows, and its dependability are very important. Cash flows that are strong, and secure, that have a steady flow, and are predictable in nature tend to be heavily prioritized and emphasized with a value investing approach. Considering it’s where a lot of its value, and its market value is derived from, it’s a very critical element to the value investing equation.
Being patient is also important when it comes to value investing. Whether it’s waiting for the cash flows you’ve projected to come in, or waiting for the market to properly correct, there is often a period of time that elapses between the two. Your cash flow calculation might take into account 3, 5, or 10 years of future earnings or dividends, or it might take a few years for the market to realize a company’s true value or earnings potential. Each investment, company, and security is different in nature, with forecasting or evaluating an accurate time table an imperfect science to say the least.
Growth Investing is different than value investing in the way you’re trying to generate returns. Part of what growth investing is about, is trying to find companies who are poised to grow their businesses, finding pockets of growth, increase the amount of revenue or earnings they’re able to generate, and further develop their underlying businesses. Utilizing a growth investing strategy, investors try to forecast which industries or companies will grow, and in return, which stock prices or values may rise as well.
It’s a bit different from value investing, in the sense that value investing is heavily involved with the underlying business, the type of cash flows it produces, and the stability or dependability of those cash flows. While growth investing is more focused on trying to find business that are poised to grow and develop that make today’s prices or values look relatively cheap or underpriced. As a company is able to generate more revenue, produce more of a profit, and continue to expand, their share prices or values, the price for a company will hopefully look like a bargain. Through the growth or development of the underlying business is where growth investors look to generate their returns, and hopefully reap the rewards as well.
The Risk and Return
Each investment philosophy, both value investing and growth investing, come with its own degree and element of risk. Every investment and company have a level of risk to it. Whether it’s in the underlying business, unknown market events or developments, or in the value or price you’re paying for a share of that company. It’s important to consider the risk within each company or investment when making your investment decisions. Risk with value investing, has a lot to do with whether the company or investment will be able to continue or maintain its earnings capability or profitability. With growth investing, its risk is more on whether the company will be able to execute on its business plan and find ways to continue to grow their business. It’s important to evaluate the risks with both philosophies, and determine which you’re more comfortable with, and which align more closely with your goals and objectives.
The returns for value investing and growth investing are a bit different in nature. Value Investing is more traditionally done with safer companies, who have secure and predictable cash flows, while growth investing is generally practiced with companies who have more uncertain or unpredictable future cash flows. Each one comes with its own level of risk, and while one may sound better than the other, the relationship between risk and reward is an important factor to consider. Both strategies can prove to be effective and produce the type of returns you’re looking for, it all depends on the type of strategy you’re looking to utilize, and what you’re comfortable with.
There are lots of reasons and examples why both Value Investing and Growth Investing have been successful investment philosophies. Both take on a different viewpoint and try to produce or generate returns using different criteria and in different ways. Value Investing is heavily predicated on trying to discover value within an underlying security or investment, through mispricing, or undervaluation. Growth Investing on the other hand, is more predicated on trying to find companies that are poised to grow, expand their businesses, and increase the amount of revenue or earnings they produce. Both philosophies come with a certain level of risk, with value investing the risk is more focused upon the dependability of a company’s cash flows, while in growth investing the risk is more predicated on the ability a company has to grow or develop its business. Trying to understand and evaluate companies underlying businesses is part of what financial analysts do. Weighing the relationship between both risk and return is important in deciding which investment philosophy works for you, and which you’re going to utilize. There is risk in both value investing and growth investing, as well as the potential for return or reward as well. All in all, value investing and growth investing are two commonly practiced investing strategies and philosophies that many investors have been able to experience success with and produce the type of returns they’re looking to generate, while factoring in the amount of risk they decide to bear, and the type of return they’re looking to generate.