Value investing vs Growth Investing: Which Is Better?

Value investing vs Growth Investing? Let's first explore the history of these two investment principles.

Value investing refers to an idea of investment that originated from Benjamin Graham & David Dodd in 1934. It simply refers to a method of buying a stock whose value is underpriced, due to fundamental reasons such as low price-to-earnings ratio (PER), low price-to-book ratio or price trading below Net Tangible Assets (NTA) per share. On the other hand, growth investing is investing in companies with above average or high growth potential. Often, investment is considered worthy even if the share price appears expensive in terms of metrics such as price-to-earning or price-to-book ratios.

As such, the term "growth investing" contrasts with the strategy adopted in "value investing". Failure to pay attention to any risk factors may result in unintended losses. So, which one provides better return, growth or value investing?

Choosing between growth and value investing is always a tough decision. Value investing is concerned with the current price level and fair price of a stock, while growth investing is more focused on the potential earnings growth of the company.

Proponents of value investors, such as Warren Buffett, has emphasized that the essence of value investing is buying stocks at less than their intrinsic value. The discount of the market price to the intrinsic value is what Benjamin Graham called the "margin of safety". The intrinsic value is therefore the discounted value of all future distributions.

Value investing
When using the PER method, a low PER is preferred, as investors believe the current low price level may be due to an overly pessimistic assessment of the company’s future prospects. Investors believe that the PER will eventually revert to its fair market level when other investors realized the "value" of the company's performance.

As a result, they rely on the movement in stock price rather than the earnings. They will search for companies with low PERs, as they expect the ratios to increase to their fair levels with or without an increase in earnings. However, value investors face the risk of misinterpreting an undervalue signal when the market’s concerns about the stock may indeed be appropriate.

Growth investing
With growth investing, its focus will be on the potential growth in earnings of a company, which has not yet been reflected in the current stock price. So, an investor may often invest even the share price has already reached a premium. Due to the high expectation, the key risk here is the growth may turn out to be lower than expectation. In some cases, growth investors may be entirely vindicated in their judgment of the quality of the underlying business, but the stock still performed badly because it was so overly priced at the time of purchase.

In addition, this method assumes a constant PER. If the PER declines for some unforeseen circumstances, investors will incur losses as a result of lower stock prices despite a higher growth in earnings.

To sum it up:
Value investing = Buy low, sell high
Growth investing = buy high, sell higher!

Value investors are always the early buyers. They buy based on the belief that the market has misread the real value of the company. At that moment, the future prospects of the company may still be uncertain; there may or may not be an increase in earnings. Thus, on top of PER, value investors will often use other measures such as dividend yield or price-to-book ratio, to support their purchase decisions.

In contrast, growth investors will come in at the early recovery stages of a company’s fundamentals. At that point in time, the stock’s price will have already moved higher from its recent low. Value investors will usually start to feel uncomfortable with the price level and sell the stock even though the company’s fundamentals have recovered, while growth investors will buy the stock in the belief that they can sell even higher even though they are buying high.
Growth investors believe that it is safer to buy stocks when the fundamentals have shown definite signs of recovery.

Hence, both value and growth investing have their respective strengths and weaknesses. Failure to pay attention to their risk factors may result in unintended losses. There is no one better method than the other. It will depend largely on one's risk appetite and timing.