If you are new to investing, there are a couple of questions that may have popped up. What is the difference between value investing and growth investing? How is investing different than speculation?
Blaine Robertson answered those two questions in the second half of chapter two of “Value Investing: A Comprehensive Beginner Investor’s Guide.” In the first half, he provided an introduction to value investing by describing its advantages, disadvantages and fundamental principles.
Value investing and speculation
According to the author, an investment is any kind of asset that is purchased with the goal of seeing it appreciate in the future. And speculation, he argued, was any venture without a concrete expectation of return. A lottery ticket is not purchased with any concrete expectation of return, it is bought in the faint hope of realizing a very big return.
Now, every kind of investing must involve some element of speculation, since the future is unknowable. However, investors do have a reasonable expectation of profit, and especially value investors with their margin of safety. Robertson added:
“The main consideration is in the amount of risks undertaken under the two terms. In speculating, the risks are higher. In some ways you can compare it to gambling. Whereas value investing takes into consideration the company's fundamentals and the prospects of the security before investments are made.”
As an example, he pointed to cryptocurrencies such as bitcoin. Given that cryptocurrencies are not backed by anything tangible, say gold or a government’s promises, they are bound to be volatile. And, as we will recall, they came out of nowhere, values shot into the atmosphere and then collapsed. That was speculation, high risk for all and high rewards for a few.
Also mentioned, briefly, in the first half of the chapter were time horizons. Speculation generally involves very short periods, while value investing requires a much longer timeline. Most often, a speculator seeks a high rate of return in a very short time, which is a recipe for losing a lot. As Robertson observed, “Speculators do not spend a lot of time with any stock or security. They move quickly, buying and selling securities within a short period in the same way as day traders.”
Nor do speculators do research on the companies they buy and sell, but rather hope to get into a “stock play”. Ignoring fundamental research, their strategy is mostly hope, along with market buzz.
Because of their approach, speculators tend to magnify the ups and downs of stock prices. On the other hand, value investors tend to take the volatility out of the market. When prices get too high, they quit buying, putting at least some downward pressure on rising prices; when prices get significantly discounted, they jump into the market and put some upward pressure on falling prices.
Value investing and growth investing
Newcomers also discover that there are several broad strategic approaches to investing. At one level, investors make a choice between fundamental investing (studying companies) and technical investing (studying what other investors are doing).
For fundamentals investors, there are two main schools: value investing and growth investing. Robertson wrote:
“The difference between the two styles is not in how they are bought or sold. The difference also does not lie in the quantity of stocks they own in a company. The major difference is in their approach to the idea of investing. The two approaches are diverse but can be used together and can complement your portfolio as an investor.”
Growth investors look for companies that are growing at an accelerated rate, which are increasing their revenues and profits quickly. And they are expected to keep growing faster than the market average. Because of that expected overperformance, many growth stocks come with high price-earnings ratios, at least in comparison with value stocks.
Quite often, growth investing is associated with new and upcoming companies. That growth is expected to be in just capital gains, since dividends are rarely paid by fast-growing companies. Robertson summarized the key characteristics of growth stocks with this list:
- High earnings growth rate.
- Growth stocks show more volatility than the broader stock market. Because of this volatility, the probability of suffering a loss is higher than it is for value stocks. A bad earnings report, for example, can lead to steep declines in the stock price.
- Growth stocks cost more than value stocks. The expectation of rapidly increasing stock prices causes investors to bid up the price of growth stocks (P/E).
As Robertson has correctly observed, there has been a long-standing argument about the two approaches, and which can deliver better returns. Some investors use both approaches, especially those who follow the different stages of a market cycle. The author summarized:
“Finally, on the question of which strategy is better, a definitive answer may not be possible. However, studies have shown that value investing is the better of the two for long term investments. Growth investing, on the other hand, offers higher short-term returns.
Whatever style you choose to employ is up to you. You have to consider the time frame you have and the funds available before choosing a strategy.”
Something worth noting, and which the author did not, was that growth investing was one of the main reasons for the dot-com boom in the late 1990s and the dot-com bust in 2000 and 2001.
Conclusion
Investing and speculation are two different approaches to building wealth. According to Robertson, speculators are willing to risk a lot of capital based on something that is not a “concrete expectation” of returns. In addition to taking on more risk, speculators have much shorter time horizons than value investors.
He has also explained that growth investors look for faster returns as well, by buying and selling companies that are growing faster than those in the rest of the market. Unfortunately, he did not tell his readers that growth investing often ends suddenly, with price plunges, causing deep hurt for those left holding the stocks.
New investors would be wise to study both topics by reading other books and resources. By knowing the potential consequences, they will be less likely to lose their capital.
Read more here:
- Value Investing: An Introduction
- Value Investing: The Basics for Beginners
- More Than You Know: Corporate Growth and Expectations
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