Saturday, 14 February 2015

The Battle Between Value And Growth

By Kevin Godbold

Both falling and rising share prices can be attractive.


I'm constantly torn between the attractions of both falling and rising share prices. 

On the one hand, the argument that shares are best bought when they are selling cheap fills my head, and on the other, the case that growing companies make good investments is compelling.

So the battle rages on; which will win, is it value or growth? Let's start by inspecting the troops
.

Left field -- value
The enticing, often sudden, falls of share prices reacting to news or sentiment can be very tempting with its sometimes elusive suggestion that a bargain may be available for the taking.

Benjamin Graham notably formularised value investing and presented his ideas in the classic 'how to' book The Intelligent Investor, which was first published in 1949.

In this book, Graham incites us to look for a margin of safety when buying shares, arguing that this is necessary because we cannot predict future business performance with any certainty. This safety margin is usually achieved by buying shares in businesses when they are selling cheaply with, for example, low price to earnings and low price to asset ratios.

However, deep-value investing became so popular that it stopped working nearly as well. In the end, investors found that good companies rarely sold at bargain prices and often, but not always, the only companies selling at dirt-cheap prices tended to be those that deserved it!

If a company is bought too cheaply, the investor could end up not with value, but with a company with such bad prospects that the best that can be hoped for is a turnaround in the company's fortunes.

Right field -- growth
Just as seductive, is the constantly rising share price of a growing company, one that keeps increasing its revenue and profits year after year. How tempting to just hop on board and ride that momentum upwards too.

Indeed, successful investors like Richard Farleigh, Jim Slater and Peter Lynch have done just that with mouth-watering results over many years.

In his book, One Up On Wall Street, Lynch regales us with stories of his past investments that have multiplied his initial capital many times over; in fact, he popularised the term ten-bagger.

Meanwhile, Richard Farleigh tells us in his book, Taming The Lion, to wait for a price trend in the right direction and temptingly adds that markets tend to move further than we think possible.

However, growth investing has become so popular that those companies with high rates of growth rarely sell cheaply. The risk that investors then run when they hop onto an upward trend is that the slightest piece of bad, or even just mediocre rather than good news, can send the share price plummeting from its lofty heights. High price to earnings or price to asset values can be dangerous.

The Truce
A great solution to this eternal battle between value and growth is to combine the two approaches. Applying a value mindset to the purchase of growing businesses with good prospects, could be a winning strategy.

Buying a growth company that has had its share price temporarily knocked by a setback of some kind, is a useful method of applying value to growth, and hopefully avoiding the pitfall of buying companies that are cheap for a reason, or paying too much for growth.

By not overpaying for growth, Graham's advice on safety margins is being observed.

To me, value means buying quality and growth at a reasonable price. If we do that, there is no battle at all!
Source: Edited article from www.fool.co.uk

Quote for the day

“Value investors are students of the game; they learn from every pitch, those at which they swing and those they let pass by. They are not influenced by the way others are performing; they are motivated only by their own results.” -  Seth Klarman