Thursday, April 26, 2018

VALUE STOCKS Vs GROWTH STOCKS - IN INVALUABLE ANALYTICAL TOOL IN LONG TERM INVESTING

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.

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