While investing, investors have to choose from a variety of asset classes e.g. Equity, Debt, Gold, Real Estate, Commodities etc. Mutual Fund is the instrument through which investors can take exposure to different asset classes and diversify their investment. However, selection doesn’t end here. Investors have to make choice between active v/s passive funds, growth v/s dividend, and value v/s growth investing in Mutual Fund itself.
In today’s blog, let’s understand the difference as well as pros and cons of Growth Investing and Value Investing.
Growth Investing and Value investing, both serve different purposes, both strategies are widely popular and adopted by many investors to create wealth.
The Fund Manager selects stocks that can substantially and sustainably grow their earnings and profits in comparison to their competitors in Growth Strategy. Growth Stocks can be found in any Market Cap i.e. Large-Cap, Mid-Cap & Small-Cap Funds. Investors expect higher growth or returns in Growth stocks in the future and hence, they are willing to invest and pay higher price for the stock.
Investors are confident about its business strategy and its predictions for development in future. Several factors such as company’s competitive position, expectation of positive reception to the company’s following product line, competitive advantage, may inspire investor confidence.
However, one point to note here is, the P/E Ratio (price-to-earnings ratio) of growth stocks are higher and thus these stocks are ‘expensive’ than their competitors. Hence, the investors are willing to pay a higher price for these company stocks than they are now earning as they believe future earnings of these stocks will justify the price.
In Value Investing, a Fund Manager selects undervalued stocks or those stocks whose current market price is less than their intrinsic worth. Intrinsic value is nothing but the potential price of the stock. Fund Manager believes that value stocks are currently trading at a lower price but they are having the potential to grow in future. For example, if the actual value of the stock is Rs. 100/- per share but it is trading at Rs. 70/- at the present, the Fund Manager will consider this to be a good value to pay.
Value stocks can be undervalued for many reasons, such as overall market scenario, legal issues, negative publicity, global factors, etc. All these reasons raise doubt about the long-term prospects of the Company. However, these are not such factors related to the fundamentals of the company. These issues listed above are recoverable. Hence, the company can bounce back slowly, and such value stocks can perform better in the long term. The Value Investing approach is most suitable for long-term investors and may carry more risk of price fluctuations than growth stocks.
Difference between Growth Investing v/s. Value Investing:
Many of my clients ask this question i.e. what is most suitable for me. Whether I should invest in Growth Stocks or Value stocks. Both approaches have suitable arguments to back them up. There are some fundamental differences between these two. In Growth investing, the key assumption is that the above-average performance will continue in the future as the companies that outperform their competitors may be new or belong to an emerging sector that can become industry leaders in the future.
On the other hand, the value investing approach focuses on mature (Developed) sectors and has predictable revenues. Value investing does not only focus on numbers.
The second difference is that in decreasing interest rates & increasing corporate earnings scenario, Growth stocks perform well. However, they may also be the first to be punished when the economy is cooling. On the other hand, value stocks are often stocks of cyclical industries. These stocks may perform well early in an economic recovery but are typically more likely to slow down in a sustained bull market.
Summary: Value vs Growth Stocks:
|Value stocks||Growth stocks|
|Price||Generally, trades at a lower price as compared to its intrinsic value||Generally, trades at a higher price as compared to its intrinsic value|
|PE ratio||Generally, has a low P/E ratio.||Generally, has a higher P/E ratio as compared to Value stocks.|
|Dividends||Generally, Value stocks have high dividend yields.||Generally, Value stocks have lower/No dividend yields.|
|Risk||May not perform well in the future as expected||Relatively high volatility as compared to Value stocks.|
|Recommended Investment Tenure||Long-Term||Short-Term to Long-Term|
|Example||Aurobindo Pharma, HCL Technologies, Coal India||Britannia Industries, Bajaj Finance, Muthoot Finance|
Growth investing v/s. Value investing; which is better?
There is no thumb rule in choosing right or wrong while investing in the stock market. Instead, both approaches offer a different set of purposes, advantages & disadvantages. Hence, investors can adopt a hybrid strategy instead of investing in one investment style. If the investment holding period is shorter, then, it is better to choose growth investing. Value stock generates more dividend income than the average growth stock as value stocks are often considered mature companies that offer more significant dividends.
Choosing one specific investment approach is primarily associated with the individual’s risk profile and investment objectives. Hence, the best way to invest is to choose a basket of stocks from both the value and growth industries.