INVESTOR EDUCATION SERIES
GROWTH STOCKS
GROWTH STOCKS
vs
VALUE STOCKS
In this INVESTOR EDUCATION SERIES, Let me discuss 2 great concepts in Investing in stock market.
Every Investor in stocks and shares must surely be conversant with these two concepts:
1. Growth stocks (or Growth Investing)
2. Value stocks.(Or value Investing)
These two concepts of investing – or investing styles - are very popular, world wide and successful investors use them in evaluating the stocks they invest in.
These two methods are, however, not two water-tight compartments.
Growth investing and value investing are not always treated as two separate methods of investment in two different types of stocks. The two are combined well, for maximum benefit of the investors.
Yet, the two concepts do convey some fundamental differences in the types of stocks an investor is looking for, the time horizon, the type of statistics that are examined and so on.
While there are many other ways of choosing stocks for investment purposes, these two have emerged as two preferred methods for knowledgeable and analytical Investors. Let us take a look at each of these methods:
GROWTH STOCKS
Growth stocks are usually identified by analyzing the following factors:
- Excellent Past Growth Rates: What is an excellent past growth rate is itself a matter for debate. It depends on factors like (i) rate at which economy is growing (ii) rate at which a particular Industry is growing (iii) maturity stage of the Industry & so on… A 10 percent growth rate (of a medium sized company) may be considered excellent in a well developed, mature economy, whereas it may be around 20 percent or more in a developing economy with a lower base effect and hence a faster growth rate. In India, a 20 percent growth rate is quite feasible for a mid-sized company, while a similar company may be growing at around 5% growth rate in developed countries. An intelligent and analytical investor can locate easily – through Fundamental analysis techniques, companies with HIGHER GROWTH RATES. Good fund managers are always on the look out for such stocks with high growth rates. There are companies with close to 45-50 percent CAGR (cumulative annual Growth rates) for the last, over 5 years, in Developing countries like India.
- EXCELLENT FUTURE GROWTH PROSPECTS : It may not always be possible that past growth rates will sustain in the future. Some sectors reach maturity stage or stagnation stage and further growth may come down to single digits. Hence, locating excellent future growth prospects is the next most important critical input. This depends on the maturity stage of the Industry, competition in the industry and so on. Each industry must be studied well for all such aspects. Locating growth stocks depends to a large extent, on locating first, good Growth Industries, within which the growth stocks exist.
- RETURN ON EQUITY : How much is the company earning on its equity? Is this growing quarter on quarter? At what rate is it growing? How does it compare with other firms in the Industry? A good growth stock must have positive return on equity which must be growing every quarter at a healthy rate. A high return on equity – but which is not growing Quarter on quarter – does not qualify for this purpose. I would not like to include companies with present negative returns in good growth stocks. They must make positive returns first. We must study the operational profits, gross profits and net profits, to understand where the strength of the company lies in earning its profits. A good growth stock must have strong operational profits, which are growing consistently. There are companies whose sales have come down drastically but whose Net profits have doubled in the same period. It would not be correct to put them in growth stocks list.
- STOCK PRICE : What is the current stock price of the company and how does it compare with Industry average? Unfortunately, Growth stocks usually are at the higher end of industry-wide stock prices. But, we must be able to project their future prices into next 5 years, based on current valuations, past growth rates, future growth prospects etc. Even growth stocks must preferably be bought at reasonable prices, at periodical corrections etc. However, it is usually advocated that once you have located a good growth stock, use the DOLLAR COST (OR, RUPEE COST) AVERAGING METHOD, to buy the stock periodically. A long term investor need not unduly be perturbed by current low or high prices. This position is true to some extent. Current high prices will look very low and cheap, after a quarter for Growth stocks. Yet, there is no harm in looking for price dips and corrections to accumulate growth stocks.
- NEW INDUSTRIES : What about new Industries and new companies under competent managements? Well. You may have none of the above criteria to satisfy. Yet, growth in such companies or industries could be FANTASTIC. A seasoned investor, who has studied different industries must be able to locate such valuable chances.
- The crux of this discussion is – you, as a good analytical investor – have a chance to invest in excellent growth companies and reap rich returns in such Growth stocks.
- DAILY STOCK QUOTES : When you are investing in GROWTH STOCKS, there is no need to bother much about daily stock prices. Yes. You must look at Quarterly results and annual results and analyze them. If you are adopting Dollar cost averaging technique for investing, invest periodically in the growth stocks, which are well-researched by you already – specially when their prices are under market-wide correction. Do not feel bad about such temporary dips in market prices. They are opportunities to BUY such growth stocks.
- TIME HORIZON: The typical time horizon - for investing in Growth stocks and reaping excellent returns is around five years. But legendary investors like Warren Buffet talk of ten years, and even, life time investing in growth stocks.
VALUE STOCKS
Value stocks can be identified by looking at the following factors.
LOW MARKET PRICE: Value stocks are typically - good stocks which are presently at low or cheap prices. Every market is imperfect and some good stocks are periodically available at cheaper prices than their industry peers. In corrections, they may have fallen well below their normal, justified prices. Some times they are at their 52 week Lows, for no valid reasons. Some times, even at historic lows. So, seasoned investors may look for value stocks at 52 week LOWs or historic lows. But, adequate caution must be exercised to understand the reason for LOW PRICE. Once a VALUE STOCK is located, an investor must understand that it will take some time for the market to recognize the correct value (price) and till such time they will remain undervalued compared to their intrinsic worth. Such exploring investors must however understand the trap of PENNY STOCKS, and must avoid the trap.
PRICE TO EARNINGS RATIO : Usually the PE Ratio (price to earnings) of value stocks is much lower than the comparable industry peers. So, one way to locate value stocks is to look at the bottom of the PE ratios in an industry. You may locate some value stocks there.
EARNINGS PER SHARE : EPS may be growing reasonably over last several quarters or even years – but no corresponding growth has taken place in the stock’s market price. This also is indicative of a value stock.
BOOK VALUE : Book value of the stock is growing very healthy – but stock price is not growing. This also indicates a value stock.
DEBT : EQUITY RATIO : The company has not much of debt. Debt : Equity ratio is some thing like 1:1-with equal or more equity than debt. And reasonable profits.
NEW COMPANIES UNDER COMPETENT MANAGEMENTS :What do you do with new companies in good industries - under strong and respected Managements? They are usually expected to succeed very well and they can be, or can become value stocks, even if some of the above criteria are not satisfied. An intelligent and analytical investor can identify them easily.
INVESTMENT NEEDED : Value stocks need typically lesser investment than Growth stocks. But, the certainty of the Growth stocks is more than that of the value stocks.
TIME HORIZON : Many investors hold value stocks for lesser time horizon and grow weary of the WAITING for price growth. They typically sell, when price exceeds a minimum profit level. But then, around that time, it is quite possible, that the VALUE STOCK is about to become a good GROWTH STOCK!
.
CAN WE COMBINE BOTH TECHNIQUES?
Surely.
GROWTH STOCKS – UNDERPRICED : One can always research and find some good, growth stocks, which are underpriced compared to similarly placed companies in the industry. In one way, they are VALUE STOCKS. They are not fancied much by market today due to market imperfections. But, a serious researcher will find that sooner or later, market has to give them better valuations.
VALUE STOCKS - ABOUT TO TURN INTO GROWTH STOCKS : It is possible to locate value stocks which are about to become good growth stocks. We must use the same techniques as for Growth stocks – except that current level of growth may be low and unimpressive but rate of growth may be significant.
HERD MINDSET : One can always find a HERD MINDSET – in some parts of the market. This acts as a psychological barrier for the market to accord correct valuations to some good companies. Even in this Information explosion age – there are information gaps – especially of QUALITY INFORMATION. Market is usually abuzz with rumours, opinions, wishful thinking and so on – which cloud quality information and create EUPHORIA in respect of certain stocks. Other better stocks get sub merged in such euphoria. But, this imperfection of the market is the opportunity for the VALUE INVESTOR. When euphoria dies down, as it surely will, value stocks come to their deserving price levels.
CONCLUSION : Making money using these sound techniques is quite within the reach of every average investor – who is willing to spend some time, learn these techniques and do some serious research of quality information. Such investors must however, avoid short term market buzz and market euphoria when they are into serious growth investing and value investing.
Other Articles in CUSTOMER EDUCATION SERIES can be read at the following URLs :
1. 1. MONEY FASCINATES:
2. MARKET INVESTMENT : ESSENTIAL RULES FOR SUCCESS:
3. SELECTING A GOOD SCRIP FOR INVESTMENT
4. INVESTMENT STRATEGIES OF WARREN BUFFET: (5 ARTICLES)
6. WORDS OF WISDOM FROM WARREN BUFFET:
7. DOLLAR (RUPEE) COST AVERAGING :
8. PRICE TO EARNINGS RATIO :
9. GROWTH STOCKS vs VALUE STOCKS : ( CURRENT BLOG POST)
10. CANSLIM TECHNIQUE :
11. PRICE TO BOOK VALUE RATIO
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