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Value vs Growth Investing – Which Style Suits You?
Education | 18 February 2010
By: Ernest Lim
Articles (134) Profile

Most of you would have noticed that these words “value” and “growth” appear frequently in fund factsheets or through experts’ lips. What do they mean? What are the pros and cons of each method? Which one is superior? In this article, I will clarify some doubts which readers may have on these ubiquitous terms.

What is value investing?

Value investing is the method of buying equities trading at a substantial discount to their intrinsic value. This is based on a premise that markets have currently mispriced the equities but will recognize its true worth over time.

Characteristics of equities which would be selected under value investing

  • Out of favour or boring equities e.g. fibre companies;
  • Equities which may have some bad news;
  • Cheap valuations such as low price to book value; low price earning multiples (PE) etc;
  • High dividend yields; and
  • Mainly big companies growing at unexciting levels

And growth investing?

Growth investing is the method of buying equities which are growing at above average growth rates. However, these equities may seem “over-priced” based on current valuation metrics such as PE ratio but this “over-priced” phenomenon decreases rapidly over time as earnings growth catch up with the price. An example is given below for illustration.

Table 1: Comparison of companies A & B with different growth rates
Source: Ernest
Source: Ernest

The prices for Companies A and B are S$40 and S$15 respectively at Year 0. Company A is growing at 50% in earnings per year whereas Company B is growing at 10% in earnings per year. At year 0, Company B trades at a PE of 15x whereas Company A trades at a lofty 40x. From year 4 onwards, Company A is consistently cheaper than Company B based on PE alone. However, it is noteworthy to readers that by buying into Company A, readers are accepting an implicit assumption that Company A continues to grow at the astronomical rate of 50% in earnings per year, at least till Year 4 (so that it is cheaper than Company B). If Company A’s growth rate falters and achieves only 15% from Year 2 onwards, ceteris paribus, it will only become cheaper than Company B from Year 17 onwards.

Characteristics of equities which would be selected under growth investing

  • Typically, small cap equities which have certain new products to be introduced to the market and are highly expected to contribute significantly to the firms;
  • Low or no dividend yields as these companies are utilizing their funds for expansion;
  • Above average valuations such as high price to book value; high price earning multiples etc; and
  • Increasing recognition on the growth potential of the equities due mainly to hype or new research reports.

Based on the analysis above, it should be apparent that both approaches have their pros and cons. These would be explained in Tables 2 and 3 below.

Table 2: Advantages and disadvantages of value investing

Source: Ernest
Source: Ernest

Table 3: Advantages and disadvantages of growth investing
Source: Ernest
Source: Ernest

Conclusion – Best of both worlds

Based on the Tables 2 and 3, it is apparent that both approaches have their pros and cons. In my opinion, I would blend both approaches together to pick stocks which offer both growth and value aspects. For example, based on Bloomberg estimates, Sinotel trades at around 5.4x FY09F earnings vis-à-vis 20.5x FY09F peers’ earnings. Sinotel earnings growth rate is estimated to be in the high teens at least for FY09F and FY10F. Thus, stocks such as Sinotel offer both growth and value aspects. My suggestion for readers is to combine the approaches together and pick stocks which offer both value and growth perspective. As Warren Buffett once said, “Growth and Value Investing are joined at the hip”. Thus, we should utilize and blend the approaches together, in order to obtain the maximum benefits.

Ernest Lim, CFA, CPA

Ernest Lim is a CFA, CA and has worked at GIC Special Investment. He has a solid feel of the markets and financial world and is now a remisier.

Please click here for more information about this author.

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