Growth and value are sometimes thought of as two different approaches to investing, but are they really that different? To be sure, the two strategies tend to deal with very different types of stocks - value traditionally operates in the universe of "boring" companies - utilities, consumer staples, etc. - while growth is more often concerned with "exciting" businesses in fields like technology and biotech (companies that have the capacity for explosive growth).
But as strategies, growth and value are really not so dissimilar. In a question-and-answer session at the Wharton School of Business, investor Howard Marks (Trades, Portfolio) explained why.
An artificial distinction
“The distinction is a little bit artificial, certainly it is not black and white. Value investing means making investments based on current characteristics and attributes and assets and values of the company. Growth investing means investing primarily on the basis of potential, and what it might look like five to 10 years from now. Clearly, everything else being equal, it’s less risky to invest on the basis of things that exist today than on the basis of things that might exist in ten years. No question.
However, it’s not that clear cut, because the value of the things that exist today is largely attributable to what they’ll produce - especially in terms of cash flow - over the next X years. So you can’t divorce yourself from thinking about the future. Let’s say you want to buy a factory - you don’t buy it for the bricks and the steel and the real estate - you buy it for its ability to produce a product that makes money. So there have to be some judgements about the future. The question really is about the relative weighting.”
Let’s unpack this idea. I have argued before that even the most conservative value investors ultimately rely upon a set of predictions and assumptions about the future. You have to assume the financials of the business in question today will continue to hold at least into the near future and you must trust that the economics of the underlying market will remain broadly stable for the next several years.
Granted, these assumptions are probably easier to make than projecting out the future sales figures for some growth company. But that doesn’t mean value investors should be blind to the fact they, too, bear risk. Just because a company looks undervalued today does not mean its underlying fundamentals won’t deteriorate in the near future (in other words, it may become a value trap).
So perhaps value and growth should be viewed as two ends of the same spectrum, rather than opposing philosophies. I’ll leave it to Marks for the last word as to what really distinguishes the two types of investor:
“My favourite quote from a fortune cookie is one I found that said, 'The cautious seldom err or write great poetry.' And so for the most part, the value investor thinks of himself as not erring so much, and the growth investor as writing great poetry!”
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