You might be initially confused by these terms or even suspect they aren’t that different in terms of what each model offers you as an investor, but they are very distinct approaches, and it’s good to understand these two schools of thought as you invest. This understanding could help you make important investment decisions, both now and in the future.[i]
At first glance, some of the advantages to each approach may not be immediately obvious, depending on what sort of market you are facing. There is an element of timing to both value and growth investing, and that concept may be helpful in understanding the differences between the two.1
Investing for Value
Value investors look for bargains. That is, they attempt to find stocks that are trading below the value of the companies they represent. If they consider a stock to be underpriced, it may be an opportunity to buy; if they consider it overpriced, it may be an opportunity to sell. Once they purchase a stock, value investors seek to ride the price upward as the security returns to its “fair market” price – selling it when this price objective is reached.
Value investors use detailed analysis to help identify stocks that may be undervalued. They’ll examine the company’s balance sheet, financial statements, and cash flow statements to get a clear picture of its assets, liabilities, revenues, and expenses.
One of the key tools value investors use is financial ratios. For example, to determine a company’s book value, a value analyst would subtract the company’s liabilities from its assets. This book value can then be divided by the number of shares outstanding to determine the book-value-per-share – a ratio that would then be compared to the book-value-per-share ratios of other companies in the same industry or to the market overall.
Investing for Growth
Growth investors use today’s information to help identify tomorrow’s strongest stocks. They’re looking for “winners” – stocks of companies within industries expected to experience substantial growth. They seek companies positioned to generate revenues or earnings that exceed market expectations. When growth investors find a promising stock, they may buy it – even if it has already experienced rapid price appreciation – in the hope that its price will continue to rise as the company grows and attracts more investors.
Where value investors use analysis, growth investors use criteria. Growth investors are more concerned about whether a company is exhibiting behavior that suggests it will be one of tomorrow’s leaders; they are less focused on the value of the underlying company.
For example, growth investors may favor companies with a sustainable competitive advantage that are expected to experience rapid revenue growth, effective at containing cost, and staffed with an experienced management team.
Value and growth investing are opposing strategies. A stock prized by a value investor might be considered worthless by a growth investor and vice versa. So, which is right? A close review of your personal situation can help determine which strategy may be right for you.