Value Stocks
Vs
Growth Stocks
(AN INVALUABLE ANALYTICAL TOOL
FOR INVESTING)
· EQUITY STOCKS, which are truly
investment worthy for long term investors, can be broadly divided into 3
categories. (1) Value stocks (2) Growth stocks and (3) Hybrid stocks. These are the preferred ones because,
they can beat the Inflation easily and provide substantial benefits to long
term investors.
·
One can invest them through Mutual
funds, Exchange traded funds or directly.
·
GROWTH STOCKS have
great future potential and because of that, they are expected to outperform
the overall market, over a number of years.
VALUE STOCKS are those that are
currently priced below their intrinsic worth as perceived by an Investor. This
gap between current price and intrinsic worth will any way be bridged by the
market in due course and provide the
investor a good return.
·
Hybrid stocks are presently value
stocks but they also have a huge future growth potential.
·
Both Growth stocks and Value stocks
tend to outperform the market in the course of time.
·
GROWTH STOCKS can be found in small
cap, mid cap and large caps .
·
How long will they retain their Growth
Potential is the important question. In some cases, Growth Potential may be
limited to 5 years. In some cases, it may extend to several decades.
·
Managements generally estimate the
growth Potential of their companies and chalk out periodical expansion plans.
·
Some Managements go for small, small
chunks of periodical growth plans, which have immediately visible benefits.
Some Managements go for huge expansion plans extending over a few years, whose
immediate benefits may even be zero but whose future benefits may be very huge.
·
VALUE
STOCKS are usually – old, established companies whose price is
somehow below its intrinsic value. The intrinsic worth may be what is perceived
by a Value Investor, through Book Value, Price earnings ratio, Price to book
ratio or some metric which indicates to him that there is significant value
lying in the company to be unlocked in future. Sometimes , there is huge land
bank, which remains unexploited currently, and, which if exploited, leads to
huge revenue gains in near future.
·
Stocks remain undervalued for many
reasons. If the CEO, Chairman or a prominent Director of the company is
embroiled in a controversy, a personal scandal, an unethical act or some such
thing which pushes the public perception of the company down.
·
The scandal may evaporate after a
month, but, the intrinsic value of the company remains the same. Then, between
market price and intrinsic value, a gap arises, which can be taken advantage of
by Value Investors.
·
Fair value is usually indicated by the
average price earnings ratio of the sector, average price to book ratio, book
value of the company, cash flows vs price and so on.
·
Value stocks are less risky than growth
stocks generally – because, the value is already there in the stock and present
price is even now lower than the value. Therefore, price is unlikely to go down
further.
·
On the other hand, as the intrinsic
value gets discovered by
market,
price can only rise.
·
Till such time, value stocks usually go
on paying reasonable dividends.
·
Growth stocks – depend on future
expected and planned growth. Anything
expected to happen in future has a degree of uncertainty and risk associated
with it.
·
Growth stocks usually have ongoing capital
intensive projects. During the execution of the projects, they may not fritter
away their funds through dividends.
·
Will the project be finished within targeted
time schedules? Will the products be up to the expectation? Will the market lap
up the products? Will there be any competitors coming up even as the company is
implementing the project? Will the profit calculations sustain after project
execution? Will the raw material prices undergo drastic revision thus,
nullifying all profitability estimates? So many such questions haunt growth
stocks.
·
And yet, Growth stocks offer the best
growth for stock investors, if the growth plans succeed. The whole economy, the
whole market, the company itself and the investors must always stand growth
oriented. Only precaution is – the parameters must be worked out a bit
conservatively, taking every element of risk into account.
·
When, as a long term investor, you are
looking at a growth stock, you need to assess the growth stock on all such
parameters, to the extent you can get hold of the information.
·
Till growth stocks achieve the planned
growth, Value stocks are likely to outperform them.
·
The Indian electricity generation
companies are an interesting case in point. Theoretically, electricity is
always in short supply and all electricity generated can be sold. But, in
practice, many companies are unable to sign the power purchase agreements with
the state electrical transmission companies for one reason or other. Huge
capital sunk in these companies is not generating the required revenue for this
reason.
·
Since future cost of generation is an
uncertain factor, these companies are always at a disadvantage. Thus, all
large, capital intensive projects stand at a big disadvantage, even if we call
them as Growth stocks.
·
At the same time, import substitution projects are usually assured of demand and
price, if Government schemes support such import substitution. Many of such
projects start on a small scale and achieve larger capacities after testing
their capabilities, market conditions and so on.
·
Growth stocks also depend on stability
of government policies. For some time, Telecom stocks achieved dizzy growth
because of stable government policies. But, when competition heated up, and
newer technologies came up, due to later government policies, profitability is
going down for all.
·
This discussion throws up many factors
which need consideration for a value / Growth investor’s success. Your
investment objective, your risk tolerance, capability to wait for a time period
are all considerations that make you a value investor or growth investor or a
hybrid investor or none at all.
·
Market itself goes through swings –
upward, downward, upward, downward and so on alternately. During these cycles,
most, but not all, stocks move up and down along with the market. At these
times, value and growth stocks may move more than proportionately. Value stocks
move down less during recessions. Growth stocks tend to move up during
expansions.
·
Growth investing is typically considered to
be the "offensive" portion of an investment portfolio, with the
"defensive" portion dedicated to income generation, tax reduction or
capital preservation.
·
Small cap stocks usually have higher growth
appetite and potential. Mid cap stocks have slightly lesser growth potential
having already grown considerably in the past. Large cap stocks are usually
matured ones with less growth appetite.
But, this is only a perception. Sometimes, large cap stocks discover
tremendous global potential and chalk out dizzy rate of growth.
·
An example is Reliance Industries, which is
constantly examining huge growth potentials in unrelated fields like Telecom
and so on. Those in Telecom field felt a huge jolt with the entry of Reliance
into Telecom.
·
Growth can also happen when a company
develops new products, new drugs, new markets and so on. Some companies are
intrinsically R&D oriented and new products often lead to new markets and
growth.
·
Return on Equity (ROE) : ROE is quantified
as a percentage that represents the company's net income (after the preferred
stockholders have been paid but before the common stock dividends are paid)
divided by the total equity of the shareholders. If return or income is same,
company having lower equity has higher ROE and company with higher equity has
lower ROE.
·
Increasing Earnings Per Share (EPS) : A company
whose EPS is increasing every quarter / every year is generally preferable for
investment compared to a company whose EPS is not increasing.
·
Projected Earnings : This is one aspects to
determine a Growth stock and invest I it. Some companies themselves give a
Guidance for future. Some Brokerages and experts try to estimate future
earnings growth of good companies and recommend them to their clients. If actual
results are higher than expected, share price will rise quickly higher.
·
Growth investing is closely linked with fundamental
analysis, technical analysis and market research. The whole gamut of Growth
investing strategies is difficult to cover in this Post. But, I do hope, I have
given the readers a good grounding in both Value Investing and Growth
Investing.
