Value and growth investing are often portrayed as different, sometimes even mutually exclusive, investment approaches. Warren Buffett (Trades, Portfolio), however, is a strong believer that this is not necessarily the case. In his 1992 letter to shareholders of Berkshire Hathaway (BRK.A, Financial)(BRK.B, Financial), the Oracle of Omaha laid out his thoughts on the subject, arguing that since growth is a part of value, the two are functionally indistinguishable.
Growth as a component of value
“Our equity-investing strategy remains little changed from what it was fifteen years ago, when we said in the 1977 annual report: 'We select our marketable equity securities in much the way we would evaluate a business for acquisition in its entirety. We want the business to be one (a) that we can understand; (b) with favorable long-term prospects; (c) operated by honest and competent people; and (d) available at a very attractive price.'
But how, you will ask, does one decide what's 'attractive'? In answering this question, most analysts feel they must choose between two approaches customarily thought to be in opposition: 'value' and 'growth.'
In our opinion, 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.
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.)”
For Buffett, there are only two options regarding the relationship between growth and value. Either a "growth" company has undervalued growth opportunities, in which case an investment in it is a value play, or the growth prospects are speculative and overvalued. When viewed through this lens, there really is no distinction between growth and value investing; the real difference is between investing and speculation.
To end with a word of warning on the dangers of growth for growth’s sake, we turn to another Buffett quote from the same letter. Some of the most prominent companies of the last decade have been growth stocks, particularly in the tech sector, which have attracted investors with the promise of even more growth. Crucially, many of these companies continue to post bigger and bigger losses, even as their top lines swell. Coworking space company WeWork recently reported its revenues almost doubled over the last year, but so did the its net loss. Is this growth adding value? Buffett would say no:
“Business growth, per se, tells us little about value. It's true that growth often has a positive impact on value, sometimes one of spectacular proportions. But such an effect is far from certain. For example, investors have regularly poured money into the domestic airline business to finance profitless (or worse) growth.
Growth benefits investors only when the business in point can invest at incremental returns that are enticing - in other words, only when each dollar used to finance the growth creates over a dollar of long-term market value. In the case of a low-return business requiring incremental funds, growth hurts the investor.”
Disclosure: The author owns no stocks mentioned.
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