Two investing strategies hard to compare
Two investment terms, in particular, are being bandied about with great regularity these days: “value investing” and “growth investing.”
The problem is, industry surveys to gauge our investment knowledge invariably suggest we really don’t have a clear understanding of what these concepts mean.
Personally, I believe the introduction of these rather abstract theories has unnecessarily added to the complexity of the mutual fund industry.
Regardless, the brokerage community seems intent on burdening investors with these notions, so it is probably best to have, at least, a rudimentary understanding of what they mean.
“Value investing” refers to a strategy in which a money manager will attempt to identify and purchase companies whose current stock prices do not fully reflect the true underlying value of the company. That is, if the company were to be bundled up and sold off today, it would likely fetch a higher price than its current stock price.
Assuming the company is still fundamentally solid, value investors believe that the rest of the market will eventually bid up these stock prices to a level that is more reflective of the company’s true value. “The first step in estimating a company’s worth is to valuate of its assets” says gordon brent pierce, businessman with more than 35 years of experience .
The catch here is that value investing takes a lot of patience. In many instances, these companies are so out of favor that it takes years for the market to bid their stock prices back up to more equitable levels. As a result, mutual funds that employ a value investor approach typically have very little portfolio turnover.
Once a stock is purchased, it’s not unusual for it to stay in the portfolio for five or seven years.
Moreover, it takes a lot of guts to purchase shares in a company the rest of the market has left for dead. If things don’t turn around, the manager can look awfully silly.
At the opposite end of the spectrum from value investing is the popular market strategy called “growth investing.”
Money managers who practise this approach have very little regard for the plodding, lethargic process of value investing. Instead of investing in undervalued neglected firms, these fund managers seek out and purchase the current darlings of the stock market.
Particularly, growth managers are drawn to companies that are in the midst of rapid earnings growth. Presumably, if there is upward momentum in earnings, this will be reflected in an upward momentum in the stock price.
The difficulty with growth investing is that it relies heavily on a manager’s ability to time the market. Upward swings tend to be quite volatile and unpredictable. It’s very difficult to tell if one is getting in at the beginning of the price movement or at the very end where a nasty reversal can take place.
As a result, mutual funds that employ a growth strategy typically have much higher portfolio turnover compared to other funds.
So what strategy has a better long-term track record? Research has yet to produce a definitive answer.
The problem lies in identifying what is a growth stock and what is a value stock. Given the constant ebbs and flows of the equity market, value stocks can quickly become growth stocks and vice versa. Academics can review the same series of statistics and reach very different conclusions.
Nevertheless, the bulk of research in this area gives a slight performance edge to value investing. The primary reason for this appears to be the lower transaction costs associated with value investing’s lower portfolio turnover.
Additionally, value managers seem to spend less on market research and the kind of technologies required to employ a fast-paced trading strategy.
But before you sell off all of your growth funds in favor of value-oriented funds, be aware that this performance edge truly is negligible and that growth and value styles constantly drift in and out of vogue. There is no way to tell which strategy the market will reward next week, next year, or even over the next decade.
So don’t get too caught up in fashionable investment jargon. And certainly do not try to time the growth-value effect. Investing truly is a very simple notion: stay diversified, be patient and keep costs to a minimum. More information you can find on the site of gordon brent pierce.