Should you be a growth investor or value investor?

Years ago, John Marks Templeton – the legendary investor who founded the Templeton Mutual Funds – observed that if you buy all the stocks selling at or below two times earnings, you will lose money on half of them because instead of making profit they will actually lose money, but you will only lose a dollar or so a share at most.

Then others will be mediocre performers. But the remaining big winners will go up and produce fabulous results and also ensure a good overall result.

Cut to the present. Every stock investor craves to make it big from investing in stocks, but only a few actually rake in the moolah. Although there are no standard or universal stock-picking strategies, analysts usually make a broad classification of retail stock-investing strategies – growth investing and value investing. In simple terms, value investors, as the name suggests, go by the value of the stock, ie looking at the fundamentals and buying stocks that are undervalued or below their worth and they believe the stock price has the potential to go north.

Growth investors, on the other hand, usually look for companies that they believe have faster growth and higher earning prospects compared to their peers or the benchmark index, which will lead to higher stock price in the future.

So which of the two categories you fall in, and which one proves better? A difficult choice indeed, say analysts, as each of the strategies has its own upside as well as downside depending on the market matrices. "Growth and value as investment styles are often misunderstood and both are risky to follow in isolation. Value typically refers to the situation of a company today whereas growth tries to predict the position of the company in the future. Of course, being cheap today is good but it is not enough to guarantee that it won't still be cheap tomorrow – or even cheaper," said Paul Cooper, Managing Director, Sarasin-Alpen & Partners, Dubai.

He said companies are often cheap for a reason and it is important for an investor following this style to identify a catalyst that will cause the stock to be re-rated. Otherwise, they risk falling into a value trap where a share price remains depressed for many years.

Growth investors are more concerned about the future, he said. The stock may look expensive today but that's because its growth prospects are excellent. The danger here, of course, is that such a statement requires the power to forecast accurately.

Sometimes, investors are required to look many years into the future to justify the current share price and the risk of forecasting error is inevitably high. Good news is often already in the price and in such cases a good fundamental performance won't be accompanied by a strong share price.

Most investors should take both styles into account before making any investment decision. Being cheap today is good but only if the future is also bright. Growth at a reasonable price (Garp) is a compromise strategy that makes sense for most investors, Cooper said.

Define time and goals

Another way to make a distinction between value-investing and the growth-investing strategy is the time an investor wants to hold the stock for, said analysts.

Value investing is more suitable when you trade the cyclical movement of stocks. In other words, value investors buy shares that are temporarily out of favour in the market and have low valuations, and it's only when the stock rebounds that they book profits, said Gary Dugan, Chief Investment Officer, Private Banking, Emirates NBD.

Analysts said at the end of the day, stock market investment carries substantial risks and it is not meant for everyone, unless one is aware of the scores of factors (technical as well as fundamental) underpinning stock market sentiment.

Stock market valuations tend to move in cycles of euphoria and desolation where expectations of the viability of current business models and growth rates are too optimistic or too pessimistic. Growth investors might gain a lot in a euphoric environment, but volatilities and drawdowns tend to be much bigger for growth stocks when reality is once again dawning on the market, added David Karsbol, Chief Economist, Saxo Bank.

He said value stocks outperform growth stocks most of the time and they actually tend to deliver long-term growth just as good as what has come to be known as growth stocks (which is just euphemistic of expensive stocks that already have had a strong growth).

Another point to consider before a retail investor goes for the growth-investing or value-investing strategy is to be sure on the purpose one is investing for, said experts.

Investors need to decide if they are investing for income (dividends) or growth, said Steve Gregory, Managing Partner, Holborn Assets, Dubai. Generally growth stocks are more risky than income generating stocks. Companies which reinvest their profits in themselves pay small dividends, but their share price may increase more rapidly. When markets dive, interest rates often dive too, but high income-producing shares become more in demand, especially if the income they pay is greater than bank deposit rates, he said.

Smart investing

Buying and selling stocks wisely requires a lot of expertise, knowledge, experience and time. In essence, one needs to be a smart investor. But what go in to be a smart investor really and what are the biggest mistakes investors usually make?

A smart investor is the one who assesses the risks as well as the opportunities and then makes a decision that is appropriate for his or her own circumstances. Greed and envy are traits which are unlikely to yield positive results, according to Paul Cooper, Managing Director, Sarasin-Alpen & Partners, Dubai.

Having made the decision to invest in a particular stock it is important to treat the investment impartially, without emotion. For example, selling a stock after a decline in value and crystallising a loss is often the most difficult, yet ultimately a rewarding decision an investor can make. "In general, I would recommend clients 'let their winners run and cut their losses early'," he added.

Related to it is getting panicked and euphoric easily, experts said. One of the biggest mistakes people make is buying stocks at the peak of the market and selling when the market is at the bottom. On the contrary, if you buy when the market is down, and sell when it's up, it can significantly increase the long-term return, said Gary Dugan, Chief Investment Officer, Private Banking, Emirates NBD.

There're times when investors lap up shares that have high dividend yields and low valuations, but this strategy doesn't work always. Therefore, there is no one-size-fits-all approach and investors need to apply the right investment strategy to the right market conditions, he added.

Being aware of the macroeconomic as well as microeconomic factors also help in taking the right investment decision, experts said. Investors need to take both the macroeconomic outlook at the microeconomic factors into account. The macroeconomic outlook might be improving, but if prices are based on the assumption of an even stronger recovery than the one that is materialising, they might not be attractive after all. One needs to address the record slack (low capacity utilisation) in most sectors and the impact on inflation and margins, said David Karsbol, Chief Economist, Saxo Bank.

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