Among the most enduring debates in the investing world is the conversation about growth vs. value investing. Investors on the growth side of the debate point to rapid rise of large technology companies like Facebook, Apple, Netflix, and Google and cite their recent outsized impact on the overall return of the broader market as evidence of growth investing’s superiority. On the other side of the aisle, value investors look up to figures like Warren Buffett and Benjamin Graham, who’s steadfast, value-focused approach allowed them to generate legendary return on invested capital over many decades. This article will provide a brief overview of growth and value-based investing strategies and provide some insight into how investors can start to explore each strategy.
Warren Buffett famously started his value investing career investing in companies he likened to “Cigar Butts”. In the 1989 Berkshire Hathaway Annual Letter, Buffett described the importance of purchasing investments at discounted prices in order to maximize profit in the long term. Low price is the key characteristic of value assets, which are typically priced at a lower point than the broader market and similar assets in the same industry as defined by metrics like the Price to Book Ratio, Price to Earnings Ratio, and the Price to Sales Ratio. Later, Buffett famously shifted his stance a bit, saying that “it’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price.” This reflects the emphasis that value investors place on robust fundamental characteristics (low debt, strong cash flow) when considering what assets to invest in.
Correspondingly, value assets tend to be larger, more established companies that have become undervalued for a variety of non-fundamental reasons, like unfavorable public perception, disappointing earnings, a one-off scandal, or a temporary industry headwind. Value investors seek to identify undervalued companies with strong financial fundamentals and invest in them at low prices with the idea that over time, the value of the asset in question will return to an appropriate level. Generally, value assets carry a lower degree of risk than the overall market and take time to turn around, which may make them more suited to long-term investors.
On the other hand, growth assets appear to be the exact opposite of value assets at first glance. Growth assets are typically priced higher than both peer organizations and the broader market in question as defined by metrics like Price to Book Ratio, Price to Earnings Ratio, and the Price to Book Ratio. However, growth assets also tend be growing much more quickly than peer organizations and the broader market as defined by metrics like year over year revenue growth, paying subscriber growth, exposure to customers, and same store growth. For growth assets, accelerated growth in these metrics translates into higher share prices and more expensive valuations. However, growth investors believe that investing in fast-moving, dynamic assets growing faster than the broader market will allow them to earn returns above and beyond the market return regardless of the price required to purchase the asset.
Growth investing strategies also tend to have shorter time horizons than value investing strategies. This is because investors in growth assets tend to pay minute attention to short term results of growth assets and to changes in their key metrics. These short-term financial results and key metrics are interpreted as vitally important to the asset’s long-term prospects. Correspondingly, short term deviations from a positive trend in metrics like revenue, sales, or subscriber growth can cause significant declines in the price of growth assets. This inherent volatility potentially makes growth assets more suited to investors with shorter time horizons.
In Part 2 of our Growth vs. Value discussion, we’ll continue the conversation on growth and value investing strategies and highlight a few options for investors interested in developing growth or value focused portfolios.