Growth and Value Investing

Fund managers often refer to their investment style in relation to the assets they manage. Growth and value are the two key investment styles fund managers talk about. The growth and value styles are complementary, rather than directly competitive, and their long term returns are relatively similar. So how do they differ?

Growth - catch the momentum

Growth investing concentrates on buying shares in companies that are growing at a rate faster than the economy as a whole.

Growth investing emphasises qualitative criteria, including value judgements about the company, its markets, its management and its ability to extract future earnings growth from the particular industry.

On observing strong earnings growth, a growth investor will decide whether to buy shares based on whether the company's growth is going to continue at its present rate, to increase or to decrease.

The key question for the investment manager is 'at which point will the company's growth flatten out, or fall?' If a company's growth rate slows or reverses, it is no longer attractive to a growth investor.

Growth investors are normally prepared to pay a premium for what they believe to be high quality shares. The potential downside is that if a company goes into sudden decline and the share price falls, the shareholding can lose capital value rapidly.

Value - looking for bargains

Value investing concentrates on buying shares in companies that are fundamentally sound and stable, but whose shares are at a bargain price because the market's confidence in the company is in temporary decline.

Based essentially on quantitative criteria, value investing focuses on asset values, cash flow, and discounted future earnings.

On observing a company's earnings growth dropping, a value manager will decide whether to buy shares based on the company's recovery prospects.

The key question for the investment manager is 'will the company's earnings growth recover and if so, when?' If a company's medium term outlook is poor, it is less attractive to a value investor, despite the low price. The key to value investing is to avoid shares that are merely cheap because the company is failing, and to look for bargain shares - prices low for temporary and/or irrational reasons.

A potential risk in value investing is that the company may not turn around, in which case the share price may stay static or fall.

The complementary nature of the growth and value styles suggests that the golden rule of investment - diversification - is as important in the context of choosing equity investments styles as it is in choosing asset classes.

Keeping the balance

The blending of styles makes sense because it can reduce the volatility in equity funds over time - a superior outcome in anyone's language.

Managed funds provide a convenient opportunity to achieve style diversification through blending. Rather than attempt to second-guess the market by switching in and out of styles as they roll with the business cycle, it is prudent to balance your investment between the two.

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