Value investing and growth investing are investment strategies based on the fundamental analysis of a company. What differentiates them is the approach used. Read this article, learn more about their main characteristics and differences, and gain a deeper understanding of the decisions regarding the buying and selling of these companies’ stock.
In both cases, the point of departure is a fundamental analysis performed to ascertain the intrinsic value of a corporation employing multiple business-related parameters. Knowing this is the first step to understand the distinctive features of each strategy. This evaluation should provide a view of every force that affects the corporation, in a scope that ranges from its internal management to the behavior of the sector. In this context, it must be remembered that publicly traded companies must file their corporate reports, which are among the most significant tools for these investment strategies.
Broadly speaking, Value Investing involves looking for undervalued companies: that is, companies whose stocks have a higher intrinsic value than their current market price. Growth Investing, on the other hand, focuses on companies with a higher growth potential than that of other firms in the sector. Further detail of their particular traits can be found in the subsequent sections.
Understanding GROWTH INVESTING
Stock analysts use models to estimate a company’s value. The filing of quarterly reports brings along an average expectation. How real data behaves compared to the average expectation becomes crucial in the decision-making process. Shares that fall within the growth category are those who have a history of attaining earnings that exceed both what was expected and the sector’s average. Additionally, the expectation that this behavior will continue in the future must exist.
The three characteristics of companies that may fall within the growth category: high earnings trend, higher volatility and higher multiples than those of their sector. There is one multiple that can be specifically mentioned: the P/E or Price/Earnings ratio, which shows the relationship between a company’s stock price and earnings per share. High multiples are sought as higher expected growth rates are believed to be a sign of higher selling prices in the future. Other elements must be kept in mind. To begin with, these corporations tend to display higher revenue growth rates, surpassing those of their sector. Also, their volatility in the face of news that could affect them is significant. This type of strategy can be applied to companies with a history of solid growth, or to new companies that are making public offerings for the first time but have significant growth potential.
Value investing, on the other hand, is a long-term strategy that focuses on undervalued companies: that is, companies whose intrinsic value is higher than their stocks’ current market price. Intrinsic value is an estimate of the value of a company that is calculated using market and financial variables. Some of these variables are free cash flows, the P/E multiple, and Tobin’s Q, among others. The rationale behind this exercise is that, in the long-term, stock prices will follow the company’s value, as it accurately reflects the fundamentals, and other investors will recognize that value.
Investors who use this approach look for two kinds of businesses. On the one hand, companies that, for some reason, the market does not find appealing, but hold solid fundamentals. For example, a company that has gone through some kind of scandal or has been involved in negative news. On the other, new companies whose potential has not been recognized by investors yet.
Growth and value are two sides of the same coin: both originate from the fundamentals of companies, but each one carries its own associated risks. The former faces sharp price fluctuations in the short term, whereas the latter may be subject to mistakes in determining the company’s potential, a mistake that could remain undiscovered for a while due to its long-term approach. Both strategies can suggest not only the movements of the market but also the expected price of the shares of stock held by investors. That is why understanding the philosophy of each strategy and the differences between them becomes essential.
This report was made by Gandini Análisis for SupraBrokers only as content. It shall in no case be considered as an investment recommendation.