Why is there a distinction between growth and value investing, when growth is part of value?

Question

I regularly come across articles about "growth vs value investing", "growth stocks beat value stocks", etc. Why is there a distinction between growth investing and value investing when growth is a component of value?

When using valuation models (e.g. dividend discount model, discounted cash flow model, etc.) to estimate the value of a business, the growth of the business is included in the calculations to arrive at a value. The future prospects (e.g. growth) of a business are obviously part of its value, so I don't understand why people speak of growth investing and value investing as if they are opposites.

Answer 1

The term "value" has multiple meanings in the stock markets. If we are talking about growth vs value we are talking about either paying for future growth defined by high price/earnings or price/book value multiple, or paying for a company with a valuable business (low P/E) or valuable assets (very low P/B) right now.
These are obviously opposites. If you are paying for current earnings of a company it would be insane to pay a multiple of 30 or 40 times. On the other hand, paying such a high multiple can be reasonable if you expect a company becoming the next big thing.

Answer 2

The difference between growth stocks and value stocks is that value stocks have a proven value RIGHT NOW and a growth stock is a promise: that they might have value in the future.

By "value" I mean proven income and assets.

For example, let's say that a company has cash and other hard assets worth $1 billion and their outstanding issuance of common stock is 500,000 trading at $1 each. Well, that's value; you could double your money by buying the company and liquidating it and yes those kinds of deals do happen. That's a value stock.

Let's take another example. A company with a capitalization of $500 million and has stock costing $1 per share and is paying dividends of $0.20 per share and is generating $250 million in profits every year. That's pretty serious value.

Now let's take by comparison a growth stock. They have no income, no assets, tons of debt and just a good idea. If you are buying their stock, you are betting that their idea will turn into value in the future.

Answer 3

You are fundamentally correct. It comes down a mis-interpretation of what 'value investing' actually means in my opinion. Most people (i.e the public) and news media outlets think that value investing is looking for companies that have low P/E, low P/B or some other arbitrary ratio. A lot of bad investors do this and then think of themselves as 'value investors' when they actually aren't.

Whereas these same people see 'growth investors' as people who invest in rapidly growing companies with huge P/E ratios.

So because of this they then separate value investors into this category and growth investors into another simply because most people understand the terms incorrectly this way.

Obviously this is totally wrong. Value investing simple means buying a stock with a sufficient margin of safety (up to the investor on the %).

For example I have bought IRobot even though it's TTM PE ratio is > 20 because I believe that it's future discounted cash flows are going to be higher than what the market predicts from my own Discounted Cash Flow.

You can see for yourself my DCF here if you want: tracktak.com/stock/irbt-us

Answer 4

You are

• wildly overthinking both terms.

• looking for scientific-like distinctions where none exist

• trying to find specific details in vague general terms

• at the very least, you're mentioning terms which both have (many) different uses, and are used sloppily and figuratively, so it's pointless/impossible to ask about detailed distinctions of the terms

Let's say we were talking about the weather. You say it's "nice" today and I say it's "pleasant" today.

On financial talk shows, terms like "value" "growth" are as vague as those terms.

Answer 5

Value Stock: A company that is earning money right now, but not expected to grow much. Typically earning are not retained, they are transferred to the shareholders through dividends or share buybacks.

Growth Stock: A company that doesn't earn much, if any, money currently, but is expected to grow and become profitable down the road. Typically retains any earnings to grow the business.

Most investors will have some of both, but some investors might bias toward one or the other for some reason.

There is no established difference in expected risk-adjusted returns for these two broad categories. If there were, it would be quickly neutralized in an efficient market.

Answer 6

As other answers point out, you are thinking about these terms out of context. In the simplest terms and without all the judgement:

value investing is looking for opportunities to purchase stocks that are under-valued by the market. It's basically bargain hunting. I once read a Peter Lynch book where he found a company whose book value was more than its market cap. He looked at the business and deemed it solid. To him, that was like getting the business for free.

growth investing is looking for companies that are likely to outperform in terms of growth rates. The price you pay for the stock isn't that big of a concern. If a stock goes to $1000, it doesn't really matter that much if you buy it at $5 or $6 dollars a share, its getting into it before the price shoot up.

These aren't really opposites: everybody wants a cheap price when they are buying and a high price when they are selling. The same stock, however, can be seen as a good opportunity or a total dud depending on which lens you are looking through.

Answer 7

Value metrics are primarily based on a heuristic that incorporates TTM ratios such as P/S, P/E, P/B (price to equity), as well as measures of the company's long-term solvency such as its gearing ratio, stable cash flows, working capital, and dividend payout ratio. These are all discrete values that disregard relative increases in sales, free cash flow, or earnings; the only thing that matters is whether or not the P/S, P/E, P/B, and P/FCF are BELOW (and thus better than) competing brands in the sector. What those values are compared to the company's history or future is irrelevant when value investing. The point is to identify companies that are trading below their fair market value.

They are generally thought to be "safer" investments because there's proof of present profitability and fiscal strength.

Growth, however, usually is based on past growth performance as well as future expected growth in sales and earnings in addition to free cash flow to the firm. Past performance or current performance factor in, and are useful in calculating the increase in sales and earnings (and thus the "forward" P/S and P/E ratios), but the emphasis is placed on RELATIVE value from year to year, not on DISCRETE values of these ratios, etc.

In the event that "forward" P/S and P/E ratios are significantly lower than their TTM counterparts, then a strong case can be made, controlling for unusual conditions (high/low levels of non-recurring costs), constraints to growth (level of cash-equivalents on hand, degree of debt), and eccentricities in Non-GAAP accounting practices, for the company to be a "growth" candidate or a "growth play".

Normally growth companies can be viewed as four types:

1. emerging technologies that are disruptive
2. newer companies with strong guidance
3. companies that are gaining market share from competitors
4. the management is finding cost-cutting procedures to increase earnings.

Think of value in terms of discrete ratios and growth in terms of percentage increases from year to year, and you'll understand why the two things are often separated into distinct categories.