November 19, 2002

The Tortoise and the Hare: Growth vs Value
by Marcel Chartier

One aspect of investing that at first was not fully clear to me was the differentiation between growth and value investing. Growth investing means buying investments that will grow in value faster than the average, usually these are smaller companies that can grow proportionably faster than larger companies because they are smaller, or they are companies in a faster growing area of the economy, in many cases technology companies. Because these companies grow faster than the market, they will carry more risk as they are more volatile as their value is determined based on perceived value of the company, which in many cases is speculation on future earnings.

Value investing is buying investments that are a deal, companies that are valued higher than what their stock price reflects. The hope here is that the value will be recognized and the stock price will rise to the value of the company's true worth - making the investor money. Traditionalists would use terms such as "half of book value" or "discount to book" value to indicate deep "value" companies. Because investments are bought at a discount to their assessed true value. The risk of losing value is less than the "average" market risk as the stock is already valued less that what it may truly be worth.

Why is knowing this important? Well, usually when growth companies do well, value doesn't do as well, and vice versa. So if you have a combination of growth and value investments this will stabilize the variations in each investment style. Now the part that used to confuse me ....

I used to think because a faster growing technology company was a growth company, it is always a growth company - no. If it collapses in value to the point where it is at a discount to book, it may now be a value investment, or it could just be another dot.com bomb. Value companies can become growth companies too, depending on how they evolve. So how does this information help the everyday investor? Knowing the types of investments you have helps in creating a balance in your investments. Understanding how companies can change also helps in understanding the risk of your investments. So, when I owned Nortel at $60.00 and its perceived value based on future earnings was $70.00, it rose to $70.00 in true growth stock fashion. When it recently traded at $.70 cents some were saying that it may now be a value stock ... depending on your assessment. Risk wise, Nortel at $.70 cents is probably a lot lower in risk than when it was at $70.00.( If you rode it the whole way down this does not make you feel any better about it.)

What goes up a lot, usually can go down a lot. What has gone down less than what it may be worth can go up to at least what it is worth with less risk. Which style is better? Both are, depending on the investments and times. Who would not have wanted to buy into a small growth company called Microsoft twenty years ago, or bought a distressed company called Chrysler at $.25 a share when it sought loan guarantees over a decade ago (as Peter Lynch did - and did very well for his Templeton fund unit holders).