Value versus Growth Investing

Value Investing - Growth Investing - Tech Stock - Earnings - Risk Adjusted Return

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I'm surprised to see the resurgence of the value versus growth investing debate. As usual in an overpriced market, value investing is declared dead while so-called growth investment thrives. Some value investors have indeed been hit hard and even forced to close their funds. Nevertheless, clients fleeing for more appealing opportunities doesn't mean value investing fundamentals are wrong. I would argue that the separation between growth and value investment is nonsense. 

Benjamin Graham championed the value investing approach in his book The Intelligent Investor and Security Analysis. Value investors study financial indicators such as earnings, cash flow, profit, and other factors such as competition or goodwill. The goal is then to buy companies that are trading for less than their intrinsic value. This process will allow investors to buy businesses with a margin of safety. By buying at a bargain price, the risk of losing money is low, and returns may be high. The quest for value investing is for cheapness. Value investors can wait years until the right opportunity offers above-average-return with lower risk. They are the most conservative investors out there. 

Growth investors invest in companies whose earnings are expected to increase fast compared to the overall market. The key is to invest in rapidly expanding industries and look for profits through capital appreciation. Growth investors make money selling their stocks as opposed to receiving dividends and staying for the long run. One famous growth investor is Thomas Rowe Price, who achieved 15% annual growth for 22 years. This strategy often requires the investor to make bold predictions regarding the forward earnings and profit margins growth. The more enterprising nature of growth investing, the high-risk tolerance, and its reliance on future events is a sharp contrast with value investing. Hence the current debate opposing value to growth. 

In his 1992 shareholder letter, Warren Buffet confessed that he was previously engaged in the "fuzzy thinking" of opposing value and growth. Buffet wrote that "the two approaches are joined at the hip: Growth is always a component in the calculation of value, constituting a variable whose importance can range from negligible to enormous and whose impact can be negative as well as positive." Investing requires to project company's future cash flows, which involve making assumptions of the growth. There is no opposition at all. Put it in the more colorful language of Charlie Munger: "The whole concept of dividing it up into value and growth strikes me as twaddle. It's convenient for a bunch of pension fund consultants to get fees prattling about and a way for one advisor to distinguish himself from another."

In my opinion, there is a misconception that value investing is buying cheap companies that aren't growing. Indeed, most "value indices" are still constructed by selecting a basket of stocks that trade at low price-to-earnings or price-to-book ratios. Benjamin Graham indeed favored an approach labeled as "cigar butt investing" by Warren Buffet. It consists of buying a company for less than its liquidation value. In other words, selling all company's assets will bring more money than the current valuation. Buffet wrote in his 1989 letter: "If you buy a stock at a sufficiently low price, there will usually be some hiccup in the fortunes of the business that gives you a chance to unload at a decent profit, even though the long-term performance of the business may be terrible. A cigar butt found on the street that has only one puff left in it may not offer much of a smoke, but the 'bargain purchase' will make that puff all profit." Thanks to Charlie Munger, Buffet later evolved into buying companies with strong competitive moats allowing them to grow their earnings over time. The oracle of Omaha still bought companies for less than their intrinsic value, the value being more abstract than the liquidation price. Buffet wrote in his 1989 letter that: "It's far better to buy a wonderful company at a fair price than a fair company at a wonderful price." His purchase of American Express in 1962, Coca-Cola in 1988, or Apple in 2016 well exemplifies that. 

The other misconception today is that growth is associated with tech companies. Some famous value investors don't invest in tech companies, thus creating a false narrative in the value v. growth debate. Buffet and Munger don't invest in tech companies because they stay inside their circle of competence. Buffet wrote: "I don't want to play in a game where the other guy has an advantage. I could spend all my time thinking about the technology for the next year and still not be the 100th, 1,000th, or even the 10,000th smartest guy in the country in analyzing those businesses. There are people who can analyze technology, but I can't." Charlie Munger summed it up "The reason we are not in high-tech businesses is that we have a special lack of aptitude in that area. The advantage of low-tech stuff is that we think we understand it fairly well. The other stuff we don't, and we'd rather deal with what we understand. Why should we play a competitive game in a field where we have no advantage-maybe a disadvantage-instead of playing in a field where we have a clear advantage." Buying tech companies can be value investing; it's simply not the specialty of Berkshire. Some value investors buy tech companies because they exhibit good business traits such as high-profit margins, high returns on capital, the ability to reinvest the profits back into a fast-growing company, and management that acts in shareholders' interests. It's not surprising at all if a value investor buys some so-called growth stocks. 

Growth v. Value seems to be a pointless debate that comes back endlessly when the market is overheating. Speculators come up with justifications about why "this time is different," labeling themselves as growth investors and creating opposition with value investors. The distinction isn't useful. Some growth investors, such as Phil Fisher, uses the concept of margin-of-safety while identifying so-called growth companies. His book Common Stocks and Uncommon Profits is a classic often recommended at Berkshire Hathaway's meeting. To further erase any distinction, the legendary Peter Lynch emphasized a dual approach now called "growth at a reasonable price" strategy. What matters is good versus bad investment, not value versus growth. 

To open up the debate, it might be time to challenge the term "value investing." Quoting Buffet"In addition, we think the very term "value investing" is redundant. What is "investing" if it is not the act of seeking value at least sufficient to justify the amount paid? Consciously paying more for a stock than its calculated value - in the hope that it can soon be sold for a still-higher price - should be labeled speculation (which is neither illegal, immoral, nor - in our view - financially fattening)". What do you think? 


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