Thursday 13 October 2011

Blend of both value and growth investing ensures stable returns


Blend of both value and growth investing ensures stable returns

13 OCT, 2011, 05.21AM IST, AMAR RANU,

Every fund manager's style of picking stocks and managing portfolios is different. While one group selects assets based on intrinsic values, the other favours companies with growth potential. These two widely followed strategies all over the world are known as value and growth investing. 

However, with the kind of volatility in the equity markets globally and domestically, fund managers often mix the two strategies to safeguard their 'style' and deliver decent returns over a period of time. 

But with individual investors, the situation is grim. Historical studies and the general consensus say that 75-90% of people who have invested in stock markets cannot explain why they own a particular stock. Their investment style is simple - if the share price is ascending and everyone is buying the stock, they will also buy. Similarly, they will sell it if it falls below a level. So, typically, investors have the 'herd instinct', a term coined in behavioural finance. 

Growth and Value investing 

Managers who seek value are also known as defensive managers who focus on the inherent strengths/weaknesses of individual companies and, as such, macro-level changes and market gyrations do not affect their style of investing. They look for stocks based on Benjamin Graham's tactics, like those with low price-earnings (P/E) or low price-book value (P/BV) ratios. 

The other ratios used are dividend yield, return on capital employed (RoCE), return on equity (RoE), enterprise value (EV), EBIDTA, etc. In a nutshell, they would invest in a stock which is at a significant discount to its intrinsic value. Globally, Warren Buffet is a wide follower of value investing who understands the management, competition and the business model, including the various ratios, in determining the actual value of a company.

Growth managers, on the other hand, target stocks that have above average earnings growth rate, low dividend yield, high price-earnings (P/E) ratio, etc. They place greater emphasis on the growth opportunities for a company and may not mind paying a price for it. So, they look for fast growing companies or those in sunrise sectors hoping to become the next Infosys or Reliance. The growth strategy is a risky strategy as the downside risk is relatively higher. 

The value-growth enigma 

Everything that appears cheap may not be a good bargain. Sometimes, the fall in stock prices happen due to a change in the dynamics of the industry concerned that are not captured in its current financials. Investors or managers buying such stocks thinking them to be value picks may end up with a dud. 

Value investing generates comparatively low, albeit stable, returns over a longer period. It causes less volatility as the fall in the inherent value of the stocks is less. Some investors associate value investing with contrarian investing, which it is not in the real sense. A contrarian transacts, ie, buys or sells a stock when a majority of the investors are behaving the other way. Such investment opportunities can happen in a rising or falling market. 

However, in an era of economic growth, growth investing strategy usually delivers higher returns over a shorter period. If there is a high growth opportunity in an industry within an economy, it will attract new investors who would invest more capital to set up new locations. As a result, over a period of time, the industry is more likely to lose its competitive edge leading to a setback to its mean growth rate. 

Which 'style' delivers more - Value or Growth? 

Across markets, the value strategy has delivered and outper formed other investment styles over a longer period of time. A study of the performance of MSCI Developed Market World Indices shows that value investing has generated significantly more returns than with the growth style over the last 25 years. Even in the MSCI Emerging Market Indices, value investing has outscored other investment styles over the last 10 years. The modern day value investor, Warren Buffet, has taken value investing to another level. 



http://economictimes.indiatimes.com/personal-finance/savings-centre/analysis/blend-of-both-value-and-growth-investing-ensures-stable-returns/articleshow/10334439.cms

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