Typically when you read about investing, you would come across the terms value investing
and growth investing
. Both mean different things, and what investment style you would use depends on the kind of person you are. I can bet, that most investors do not really understand the difference between value investing and growth investing. If you are one of them, this would be a good time to get it right.
Value investing is the strategy of selecting stocks that trade for less than what they are really worth. Value investors keep looking for stocks that are under priced but have excellent financial record. This information can be obtained by looking at the financial statements (balance sheet, income statement). Value investors typically take into consideration attributes like low price to earnings ratio (P/E), price to book ratio (P/B), price to sales ratio (P/S) and high dividend yields. In short, value is defined based on low valuations (low price ratios and high dividend yields) and slow growth (low growth rates for earnings, sales, book value, and cash flow).
Value investors beg to differ. They generally do not agree with the fact that current market price of a stock reflects all the information there is to know about the company. Value investors tend to put more weight on their judgments about the extent to which they think a stock is mispriced in the stock market. They will buy the stock, if they believe it is under priced and sell it, if they believe it is over priced. The art most value investors try to master is buying stocks of good companies going through a rough patch, because that is the time when the stock price will be under priced. Value investors would then ride out the rough patch and reap in their gains during better times, eventually selling them when their fair value is reached.
Growth investing works exactly opposite to that of value investing. Growth investors focus on stocks with faster growth potential.
Growth investing is the strategy of selecting stocks that show signs of faster growth. Growth investors keep looking for stocks that will grow faster compared to its industry or the overall market. Growth investors focus on stocks trading at high P/E, P/B and P/S ratio and do not care much about dividend yields. In short, growth is defined based on fast growth (high growth rates for earnings, sales, book value, and cash flow) and high valuations (high price ratios and low dividend yields).
Value versus Growth
Value investors generally plan to hold the stock for a longer duration, since they believe over a period the stock will come out with flying colors. Value investors are generally patient investors. On the other hand, growth investors believe that soon the company will grow rapidly and so will its stock price. Growth investors are generally in for short time frame compared to value investors. In general, value stocks tend to hold up better during stock market downturns.
So are you a Value Investor or a Growth Investor ??