Value investing includes buying an undervalued stock and then selling it when the market at last recognizes the company's potential. In simple terms, value investing can be considered as investing in something that the market presently values less than what it is actually worth. The concept of "value" might be different for different investors. While some of the investors consider only the present assets of a company for determining the intrinsic value of its share, others estimate it based entirely on the company's growth prospects.
How is Value Investing Done?
Value investing usually involves the buying of under-priced shares. Now, whether the share is under priced or not is established or known by some forms of fundamental analysis. Examples of such under priced securities include stocks that have -
- High dividend yields.
- Low price-to-earnings multiples.
- Low price-to-book ratios.
Benefits and Dangers of Value Investing
The ability to judge and select a company with strong fundamentals can give significant earnings in the long run. It has been empirically noticed that value stocks outperform growth stocks. By compounding through dividends, value stocks can be among the most profitable investment options in one's portfolio. However, owing to the huge number of companies that float their shares in the market, it becomes very difficult to find a stock of a promising company which is undervalued by the market.
Besides, over dependence on the model of value investing can minimize one's earnings potential. It is important that investors take their sentiments into account, as this plays a vital role in the movement of stock prices in the market.
Growth investing is a strategy which involves investing in stocks which have above-average growth potential. Such investments are carried out even in situations where the price of such shares appears high in terms of the price-to-book or price-to-earnings ratios. An investor who adopts the growth investing strategy is known as a growth investor.
How does Growth Investing Work?
Growth investing strategy is executed in several ways. These include investing in blue chips, emerging markets, recovery shares, smaller companies, Internet and information technology stocks, special situations and second-hand life policies.
The appreciation in the value of growth stocks is fairly fast and high. For about 5 years preceding the 2000-2001 dot com bubble burst, the growth stocks performed better than value stocks.
After the end of dot com era, value stocks have been performing much better than growth stocks. This is why a 50:50 investment strategy (i.e. half the portfolio is created by applying the growth investing strategy and the remaining comprises of value stocks) has been widely advised by financial analysts.
Growth Investing Strategy: Benefits and Risks
Growth investing is many a times used by investors for maximizing their capital gains. Hence it is also known as 'capital growth strategy'. However, the application of the growth investing strategy can adversely affect one's aim to diversify their investment portfolio. It would be dicey to attach a high price to a security in hope of benefiting from its growth. The security price may crash down if the growth rate fails to live up to expectations.
Growth investing can be considered as a converse to value investing because in case of growth investing the investments are made only when shares are cheap.