Growth Versus Value

The basic distinction between growth and value is simple: Value investors like to buy cheap stocks, while growth investors like to

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invest in good companies. These two preferences usually conflict: Cheap stocks are usually not stocks of good companies. Life gets more complicated when we ask how to tell whether a stock is cheap, or a company is good. The standard measures of cheapness would include some of the following: low P/E (price divided by earnings) ratio, low ratio of price to book value, and high yield (ratio of dividend to price). The standard measures of high quality would include high earnings growth, high return on equity, high profit margins, strong management, and dominant industry position.

The value investor worries mainly about what he is paying; the growth investor worries about what he is getting. The problem is that usually you get what you pay for. If you're a real cheapskate, you wind up owning shares in lousy companies. If you like to invest in good companies, you aren't likely to buy them cheap. The challenge is to manage the tradeoff between what you're paying and what you're getting.

Warren Buffett is often revered as the dean of value investing, but Buffett has no interest at all in buying cheap stocks. He routinely makes fun of the "cigar butt school of investing" and is fond of saying that he would rather buy a great company at a good price than buy a good company at a great price. In the crunch, he is more interested in quality companies than in cheap stocks.

The hedge fund community, like the mutual fund community, includes managers from every point along the growth-value spectrum. At one end are deep-value managers who are so concerned with price that they often wind up investing in companies that look pretty unappealing. At the other extreme are aggressive growth managers who are so concerned with earnings growth or other measures of corporate excellence that they often pay very little attention to the price that they are paying. This is the "growth-at-any-price" approach. And then there are all sorts of managers in between, reflecting different ways of managing the tradeoff between cheap stocks and good companies. The growth-at-a-reasonable-price strategy is somewhere in the middle of the spectrum.

Growth-oriented investors are often momentum-driven, and value-oriented investors often have a contrarian view of the world. But there are exceptions. Some growth investors have a contrarian element in their approach: They like to buy growth companies when they are temporarily depressed. And some value investors have a momentum element in their style: They like to buy cheap stocks only when they are already beginning to show signs of turning around.

Lessons From The Intelligent Investor

Lessons From The Intelligent Investor

If you're like a lot of people watching the recession unfold, you have likely started to look at your finances under a microscope. Perhaps you have started saving the annual savings rate by people has started to recover a bit.

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Responses

  • marigold
    Are hedge funds value or growth style investors?
    29 days ago

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