STOCK MARKETS

Just as people choose food and clothes according to personal tastes, some people take investment decisions like buying stocks or mutual funds by styles.

"Growth" and "value" are two of the most popular investment styles in investing.

Warren Buffett, John Templeton and other value investing legends built huge fortunes by never overplaying in the stock market.

There are always opportunities to pick stocks that have fallen in price which might become the equivalent of "cut price specials" or "value stocks".

Conversely, growth stocks always have takers. Everyone wants to own "growth stocks" that keep increasing in price. Growth and value fundamental investment approaches have been the subject of significant research.

How do you identify growth and value stocks?
While earnings of some companies may be low during periods of slower economic growth, growth companies seek to achieve better earnings growth regardless of economic conditions.

Value stocks are those that generally have fallen out of favour and are considered bargain-priced compared with book value, replacement value or liquidation value. Typically, value stocks are priced much lower than stocks of similar companies in the same industry. The value group may also include stocks of new companies that have not been recognised by investors.

Some of the valuation measures in the two categories are listed below:

The primary measures used to define growth and value stocks were the price-to-earnings ratio (the price of a stock divided by the current year’s earnings per share) and the price-to-book ratio (share price divided by book value per share).

Growth stocks usually have high price-to-earnings and price-to-book ratios, which means that these stocks are relatively high-priced in comparison with the companies’ net asset values. In contrast, value stocks have relatively low price-to-earnings and price-to-book ratios.

While earnings growth was used to decide the growth parameter, dividend yield was used to shortlist value stocks. Current ratio - a good parameter to decide the liquidity of the company by calculating the ratio between current assets and current liabilities, was also used to filter stocks initially.

The analysis was based on the parameters shown in the table below.

Which style is better?
The debate between growth and value investing has been going on for years, with each side offering statistics to support its arguments.

Both styles have their positives and negatives and make different demands on investment research.

However, a truly diversified portfolio has both value and growth stocks. If you find only one kind in your holdings, consider the benefits of diversification.

Most growth investors are willing to pay a fairly high price for a stock whose earnings they expect to blow up. They aren't completely insensitive to price, but the question of whether a stock is cheap or expensive isn't the paramount question for them. The crucial question is what earnings will be in two to five years.

Value investors, on the other hand, view cheapness as a major virtue. They focus on stocks that are cheap. Just as growth investors aren't totally insensitive to price, they aren't completely indifferent to earnings progress. However, they're willing to sacrifice some earnings growth for the sake of cheapness.

One last important point to remember is that in value investing, correct stock valuation as well as the right time of entry is very critical. While, in growth investing, it is essential to identify businesses that face little or no threat of erosion so that earnings growth of those companies is not impacted.