Examine growth expectations

Understand what kind of growth rates are incorporated into the share price.

If the rates of growth are unrealistic, avoid the stock.

Growth Investing

The Conventional definition:  An investor who buys high price-earnings ratio stocks or high price to book ratio stocks.


The Generic definition:  An investor who buys growth companies where the value of growth potential is being underestimated.   


In other words, both value and growth investors want to buy undervalued stocks.

The difference is mostly in where they think they can find bargains and what they view as undervalued (value of the growth assets versus the value of the assets per se.)

If you are a growth investor, you believe that your capability edge lies in estimating the value of the growth assets better than others in the market.

Growing versus Non-growing company. Value Investing versus Growth Investing.

A growing company versus a non-growing company


Given the choice, you should choose to invest in a company that is growing its revenues, earnings, and free cash flows over time.  This company continues to grow its intrinsic value and over time, you will be well rewarded for investing in it.


Is investing into growing companies the same as growth investing?

Let us illustrate using company Y.  Company Y is a company that is growing its revenues, and earnings 15% per year, consistently and predictably for the last 10 years.   

At certain times, Company Y is available at a P/E of 10.  Buying Company Y at this stage is a bargain.  It is available at a bargain price.  This is value investing.  If you use PEG ratio of Peter Lynch, it is available at a PEG ratio of 10/15 which is < 1.   

At other times, Company Y is available at a P/E of 20.  Buying Company Y at this stage is not value investing.  Those who buy at this P/E may feel they are also buying a bargain, as they projected that the earnings of Company Y is going to be great and the growth in earnings higher than the 15% per annum in the past.  Maybe they projected that the earnings will be growing  30% per year.   This is growth investing.  If you use PEG ratio of Peter Lynch, it is still available at a PEG ratio of < 1 (= 20/30).

Thus, is there a difference between value investing and growth investing, from a bargain perspective?   There appear to be 2 sides of the same coin.  Those buying into the stock using these strategies are of the opinion they are buying a bargain.   

However, there are differences too.   Historically, value investing has outperformed growth investing when assessed over a long time frame of investing.  But beware of such analysis.   Among the value investing stocks selection, many of the companies did not perform as expected and the fundamentals tanked.   Likewise, those stocks in growth investing, projected to grow at high rate and bought at high P/E, failed to deliver the growth and did not perform as expected.  

Let us learn from Buffett.  Stays with the company that you understand.  This company must have business with durable competitive advantage.  Its management must have unquestionable integrity.  Finally, buy them at a fair price.  

Yes, search out for the growing companies.  I too love such companies.   Above all, emphasizes the quality of the growth of business and its management.   Finally, look at the price (valuation).   Whether it is value or growth investing, buy growing companies at reasonable price (GARP). 

What's Investing Style?

Understand Investment Styles and Determine Which Fit Your Portfolio.

By Melissa Phipps

Successful investors and investments don't just pick companies on a whim. They narrow their focus on investment styles. They may target companies of a certain size, look at company fundamentals as a predictor of long-term value or annual growth, manage every stock move or set the investing on auto-pilot. Most mutual funds or ETFs have a pre-determined style that does not (or should not, sometimes funds get tricky) vary. Often, these investments target a combination of styles. So how do you make sense of it all? Learn the types of investment styles, and it can help you determine which investments best suit your style.

1. Investing by company size: Large Cap, Mid Cap, Small Cap

Companies perform in different ways at various times in their growth cycles. Investors focus on capturing companies at different points—when they are just starting, just starting to grow, in mid-growth, or well established. You can do this by focusing on market capitalization, or the number of outstanding shares multiplied by share price. Large capitalization or big cap companies are those worth more than $10 billion. Mid-caps or mid capitalization companies are about $2 billion to $10 billion. Small-caps or small capitalization companies, between $100 million and $2 billion. There are micro-caps below that, then nano caps, then... I guess angel investments. Fund managers typically choose a market capitalization to focus on. For example, "This fund seeks to generate capital appreciation by investing in small cap companies" or, more specifically, "This Fund seeks capital appreciation principally through the investment in common stock of companies with operating revenues of $250 million or less at the time of initial investment."

So what's the difference? Typically, small-cap companies offer more growth potential. If you get in at the right time (think early Microsoft, 1990s Apple), you can get a great investment return. But small-caps can be riskier than established large-caps. Only the strongest small companies survive. The risks increase as companies get smaller. Micro-, nano- and other tiny-capitalization investments could have serious potential, but unless you are a very agressive investor and can afford the loss, they shouldn't represent a huge part of your portfolio.

Large-cap companies move the market. They are the dominant players, produce consist returns over time, and may even return dividends to investors. They are also liquid companies, meaning it's easy to buy and sell their shares. There typically offer decent returns with less risk, and since they represent the larger market these companies should play a dominant role in your portfolio.

In between are mid-caps, which some investors think is a sweet spot where you can find companies with growth potential that act like value plays (more on growth vs value below).

Different-sized companies seem to perform differently, meaning when large caps are down, small move up. These are assets that are non-correlated, they don't move in the same way. Owning companies of each size helps to balance some of the risk of your portfolio.

2. Investing in company fundamentals: Growth Investing and Value Investing

Some investors use analysis of fundamentals to determine where a company is headed. Growth investors look for companies they think will increase earnings at least 15% to 25% a year on average, based on management, new products, competition, etc. Value investors look for companies that are selling cheap compared to intrinsic value or the value of tangible assets.

For many investors, the real win is a combination of growth and value. A good company with solid long-term prospects at a reasonable price. That's super investor Warren Buffett's way (he doesn't believe in the two separate strategies).

3. Investing with or without a manager: Active vs Passive

An actively managed fund is one with a manager or team of managers picking stocks in an attempt to beat the market. A passively managed fund, also known as an index fund, follows a set group of stocks to achieve its stated goals. Index funds perform like the index they follow, and because there is no one to pay the expenses are typically cheaper than actively managed funds.

Active managers can try to reduce risk when the markets are turbulent, but managers rarely beat the markets by enough to justify the extra expense of an actively managed fund. A recent study found that only 24% of actively managed funds beat their passive counterparts.

4. Investing in a market segment: Sector Investing

Some investors narrow their style to invest in a specific industry or sector, say technology, consumer goods or manufacturing. Sector funds are not diversified in and of themselves, but they can help balance out a portfolio that is heavily weighted in a certain sector because it contains a lot of company stock, for example.

A balanced portfolio can contain a combination of the fund styles mentioned above. It really depends on your personal tolerance for risk, your goals, and the types of investments available to you through your 401(k) or individual retirement account. You can use an asset allocation calculator (this one from Bankrate) to figure out what's right for you. (Some people are just as well off putting everything in an index fund, which is just a cheap way to own the entire market, or a target retirement fund, which does the asset allocation for you.) Choose based on what works for your own investment style.

http://retireplan.about.com/od/investingforretirement/tp/What-Is-Investing-Style.htm

Growth is simply a calculation used to determine value.

Value is the discounted present value of an investment's future cash flow; growth is simply a calculation used to determine value.

People who consistently purchase companies that exhibit low price-to-earnings, low price-to-book, and high dividend yields are customarily called "value investors."  People who claim to have identified value by selecting companies with above-average growth in earnings are called "growth investors."  Typically, growth companies possess high price-to-earnings ratios and low dividend yields.  These financial traits are exact opposite of what value investors look for in a company.

Investors who seek to purchase value often must choose between the "value" and "growth" approach to selecting stocks.

Buffett admits that years ago he participated inn this intellectual tug-of-war*.  Today he thinks the debate between these two schools of thought is nonsense.

"Growth and value investing are joined at the hip", says Buffett.



*Comment:  It is interesting to know that Buffett too had been through these intellectual debates and then formed his own conclusions.

Why You Should Invest in Growth, Not Value

by Alexander Green, Investment U Chief Investment Strategist

Tuesday, September 25, 2012

Patrick Henry famously declared that he knew no way of judging the future but by the past.

So if you're putting together a long-term investment portfolio, it might be wise to look at the historical returns for various types of assets. Not just for the past few years, or for several decades, but for the past couple centuries...

When you do this, you'll notice something interesting:

·        Owning a portfolio of businesses (stocks) has generally been much more rewarding than making loans to corporations or Uncle Sam (bonds) or sticking your money in the bank (cash).

·        Look closer at the clear winner (equities) and you'll also find that value stocks have outperformed growth stocks over the long haul and that small-cap value has beaten large-cap value by a substantial margin.

It therefore follows that an investor seeking maximum capital appreciation might focus on identifying undervalued small-cap stocks.

But there's only one problem with this: It won't work for most investors, even if the future is very much like the past. Here's why...

Beware the Infamous Value Trap

Value stocks require something that growth stocks don't: Patience.

When a stock - either large or small - is in the cellar, it's there for a reason. Typical ones are that the company is:

·        Losing market share...

·        Seeing its margins fall...

·        Is losing money...

·        Or is experiencing flattish sales and declining profits.

As a value investor, you don't know when this state of affairs will end, but you might be tempted to invest in a company if it's relatively cheap in relation to sales, earnings, or book value (i.e. net worth) in the hope that management will set things right.

The problem is this can take quite a long time. Or it may never happen at all. As the stock gets cheaper and cheaper, you may believe it's becoming an even better bargain. This is the classic "value trap." And if you keep buying a stock on the way down, it may very well have your name on it when it hits rock bottom.

Dead Money With Decent Dividends 

Even if a value stock is destined to generate a good return over, say, a three- to five-year horizon, most investors won't be around to enjoy it.

How do I know this? Because as a former money manager, I've dealt with thousands of "typical investors." And regardless of what they say in their initial interview about their willingness to stay the course and think long term, it all goes out the window for 90% of them when the road gets bumpy. Or if things don't kick into gear right away.

A client who sits on a stock - or even a stock fund - for six months and doesn't see a spark will remind you with every conversation that he or she is sitting on "dead money."

No argument there - they are (at least temporarily). But value stocks often pay decent dividends that help compensate for this. Early in my career, however, I got tired of holding hands and counseling patience and switched from a value to a growth methodology.

It was a good move. If you want action, you should have it...

There's No Shortage of Excitement With Growth Stocks 

Buy the best growth stocks you can find. Given that they tend to be twice as volatile as the market (and twice as expensive), there is generally no shortage of day-to-day excitement.

But if you use a trailing stop, you can generate results that are much better than historical long-term returns (which always assume a buy-and-hold approach) and with less risk because your positions are fully protected.

So unless you have the patience of Job - and most investors don't - you're better off owning growth stocks than value stocks and, of course, using a trailing stop. 

Good Investing,

Alex

Focus on Investing in Growth Companies for the Long Term

Since the early 1940s, when World War II brought the Depression to an end, there has never been a long-term catastrophe in the stock market.  Even in the worst of times, good companies continue to earn, and many stocks buck the trend.  To be sure, some of the weaker companies with poor management fold, but the well-managed, strong companies quickly scoop up their market share and life goes on.

Focus on investing in growth companies for the long term and , if the time arises when you need to take cash out of your account, sell off portions of your losers - the ones whose sales and profit growth is sluggish, not necessarily the ones whose prices are down.

This will assure you that when the market comes back up, which it surely will, you'll have a portfolio of winners.  Have faith that the companies you own a piece of will perform well in the long term and so, therefore, will your investments.  (And gloat as you continue to rack up 15-percent years while your contemporaries are pulling down 6 percent and paying the taxes on it every month.)

The History and Rebirth of Growth Stocks Investing.

By BetterInvesting On April 5, 2012 ·

The editorial of the January issue of BetterInvesting Magazine features a letter from Ted Brooks of North Carolina, who provides a brief history of growth stock investing and the important role BetterInvesting co-founder George Nicholson played in popularizing this investing philosophy. In 1940, when Nicholson was just beginning his “bold experiment” of helping individual investors form investment clubs to pool resources and analyze stocks, growth stock investing was no longer in vogue, replaced by Benjamin Graham’s value approach in light of the 1929 crash.

January 2012 vol 61, No. 5 BetterInvesting Magazine

Reader’s Letter Provides Context for the SSG (The Stock Selection Guide)
In investing circles we tend to take some ideas for granted. In August 2005 we published an article discussing the history of growth stock investing. But a recent letter from reader Ted Brooks of North Carolina, spurred by our article on Better¬Investing’s 60th anniversary in the November issue, provides an excellent history lesson. Below is his letter, edited for Associated Press style and length.

When the Dow Jones industrial average was introduced on May 26, 1896, the world of common stocks was beginning to evolve into three distinct categories: railroads, public utilities and “industrials” (everything else). It is important to note that the “industrial” common stocks were not considered an appropriate investment vehicle for the prudent investor at that time; such investors would limit their holdings to bonds, preferred stock and perhaps an occasional railroad or public utility common stock. This attitude prevailed until around World War I.

While eschewing common stock for bonds and preferred stock sounds strange to our ears, it was not without justification. The DJIA started off as an arithmetic average of the stocks’ closing prices. In other words, the average price of stocks in the DJIA initially bounced between about $40 and $80 and did not break $100 until 1906. What few people realize is that prior to 1915, common stock prices were quoted as a percentage of par value (like bonds and preferreds), and par value was typically $100. If these sound like “junk bond” prices to you — you’re right!

During this period, value investing — focusing on dividend yields, low P/E and discount to book value — prevailed. These concepts carried over readily from the realm of bond and preferred stock analysis.

The man generally credited with introducing the concept of growth stock investing is Edgar Lawrence Smith. Smith’s book, Common Stocks as Long Term Investments, stated that common stocks had a history of outperforming bonds under all economic conditions, going back at least to the end of the Civil War. Now, in early 1925, both the book’s title and theme were outrageous statements that flew in the face of all prevailing logic — something present-day investors do not fully appreciate. Unfortunately, Smith’s book and ideas would see a meteoric rise and fall. …In the first edition of Security Analysis (c. 1934), Benjamin Graham wrote a harsh criticism of Smith and his “growth stock” ¬disciples, and he urged investors to go back to the old rules of valuation that were discarded as obsolete during the bubble (leading to the 1929 crash).…

Against this backdrop, it is easier to understand George Nicholson’s courage in proposing the idea of investment clubs in 1940. Individual investors analyzing stocks? Buying growth stocks? George, where have you been for the last decade — living under a rock?

The BetterInvesting principles of demanding consistent growth in sales and earnings over a period of five-10 years, stable or increasing profit margins and closely watching valuations did not come out of thin air. They all came out of the hard lessons learned in the late 1920s when they were disregarded (as they were during the tech and dot-com bubble of the late 1990s). Nicholson recognized that focusing on these aspects — together with a graphical representation known as the SSG — allowed new investors to gain experience without wading into the trickier aspects of differentiating between a “value play” and a “value trap.” Nicholson’s “bold experiment” required a leader possessing both courage and clear thinking to make it reality in that historical context. I think all of these things combine to make Nicholson’s legacy what it is.

http://blog.betterinvesting.org/investing/the-rebirth-of-growth-stocks/

Warren Buffett's approach to Growth. Growth on its own is not a valuable thing as a rule.

Benjamin Graham's approach.

Look first at Assets.
Then look at Earnings Power - making sure that they are protected by the assets.


Warren Buffett's approach.


Look at Assets and Earnings Power.
Only then, look to pay something for Growth.
Growth is only valuable if the return on investment in growth is greater than the cost of capital.
If not, growth can destroy value.
Growth on its own is not a valuable thing as a rule.
If you are going to buy growth, you better be sure of the franchise value.

Character Traits Of Value Investors

In his 2002 book The Valuegrowth Investor, Glen Arnold describes the character traits and personal qualities of a ’valuegrowth’ investor as follows: (Note: Arnold describes the ’Valuegrowth’ investor as a distillation of the principles used by Ben Graham, Warren Buffett, Charlie Munger, John Neff, Philip Fisher, and Peter Lynch... a fine crowd indeed!)

To be successful investors we need to develop the ability to keep emotions from corroding the advantages brought by the Valuegrowth framework. The following qualities are needed:

Independence of mind: The market is full of beguiling rationales for the current consensus view. The Wall Street crowd has a tendency to follow a few lead steers like manic-depressive lemmings. Don’t accept Mr Market’s judgment of value. Think independently. Gather facts, apply tests and standards, and critically evaluate the business using sound principles.

If you do all these things you will have confidence and courage that comes from knowledge, experience and sober reflection. It does not matter that the popular view is different to yours. Be prepared to cut yourself off from the crowd and zig when the rest of the market is zagging. Be prepared to think and to act unconventionally--to go with your own reasoning. Be somewhere that allows you to ponder the really important issues--get away from the day-to-day stock market stimuli. Don’t be intimidated by the ’professional investor’. Remember: the vast majority of ’professionals’ fail to outperform their indices. The Valuegrowth investor is far superior to most Wall Street analysts.

Capacity for hard work: Valuegrowth investing requires full commitment. A good knowledge of strategic analysis, accounting, finance and economics are required. A willingness to spend time in scuttlebutt is necessary. The rewards of the Valuegrowth method are huge, but it asks for constant toil.

The ability to make decisions with incomplete information: In investment we are making judgments about the future. Owner earnings that are yet to occur cannot be stated with any great precision and yet we must still form a view. If you are uncomfortable with analysis based on shaky numbers and ball park figures; if you require facts that are provable before you can make a decision then you will not make a good Valuegrowth investor. Investment is a probability-based art form. The successful investors tilt the odds in their favor.

Resistance against the temptation to speculate: Discipline is needed to stick to sound investing criteria. This is especially the case in bull markets when you see speculators making vast returns. Don’t be tempted to play catch-up hoping to get your money out before the crash and return to thorough-investigation-with-a-margin-of-safety-investing later. You are more likely to go down with the rest, as Fisher and Graham discovered in 1929. You must resist emotions and gut feelings. Like the dog in Aesop’s Fable stick with what you know to be good rather than lose it trying to grab for deceptively better offerings. Buffett is content to aim for 15% annual appreciation. Why should we think we can safely aim for more than that.

Patience, perseverance, fortitude and consistency: Valuegrowth investors are not impatient to buy stocks. Stand on the plate and let the bad pitches pass by. Do not drop your standards. Patience, perseverance and fortitude are also needed when the stock price falls after purchase. Doubts about the wisdom of the investment start to appear. If you have done your homework and you are convinced that the stock represents good value then a falling price creates buying opportunities if you hold your nerve. Market pessimism is the friend of the investor, but it takes a strong will to stand against the tide of opinion.

Don’t be impatient to sell-- hold on to good stocks. It sometimes seems ages before the market recognizes the intrinsic value of a stock. If you hold on you can benefit from both rising earnings and an increase in the price-earnings ratio. On other occasions the price can rapidly appreciate and you are showing a good rate of return. The temptation is then to cash in your chips. This often needs to be resisted too. The best part of the return may yet be to come.

The Valuegrowth investor is consistent in his or her investment activity. Do not switch investment styles. Have a regular routine of investment following best practice. Even following Valuegrowth investment principles there will be down years. In these periods resist the temptation to give up and try the latest fashion. Also, consistency is needed in continuing to follow the story of the company. On a regular basis investigate if the story is still strong enough for you to hold.

Willingness to admit and learn from mistakes: Mistakes are bound to occur in investment. It is impossible to be right about companies all the time. In fact, excellent performance only requires us to be right six times out of ten. When a mistake does occur don’t sweep it under the carpet because you can’t bear to look at it and be reminded of your ’failure’. Face up to it, examine it and learn from it. In this way the quality of your investment decisions will improve. Also, learn from the mistakes of others-- ’you can’t live long enough to make them all yourself’ (Martin Vanbee).

http://www.sap-img.com/stock-market-investment/character-traits-of-value-investors.htm

Benjamin Graham and The Power of Growth Stocks

Benjamin Graham and the Power of Growth Stocks: Lost Growth Stock Strategies from the Father of Value Investing

by Frederick K. Martin CFA & Nick Hansen

Use a master's lost secret to pick growth companies bound for success In 1948, legendary Columbia University professor Benjamin Graham bought a major stake in the Government Employees Insurance Corporation. In a time when no one trusted the stock market, he championed value investing and helped introduce the world to intrinsic value. He had a powerful valuation formula. Now, in this groundbreaking book, long-term investing expert Fred Martin shows you how to use value-investing principles to analyze and pick winning growth-stock companies—just like Graham did when he acquired GEICO. Benjamin Graham and the Power of Growth Stocks is an advanced, hands-on guide for investors and executives who want to find the best growth stocks, develop a solid portfolio strategy, and execute trades for maximum profitability and limited risk. Through conversational explanations, real-world case studies, and pragmatic formulas, it shows you step-by-step how this enlightened trading philosophy is successful. The secret lies in Graham's valuation formula, which has been out of print since 1962—until now. By calculating the proper data, you can gain clarity of focus on an investment by putting on blinders to variables that are alluring but irrelevant. This one-stop guide to growing wealth shows you how to: Liberate your money from the needs of mutual funds and brokers Build a reasonable seven-year forecast for every company considered for your portfolio Estimate a company's future value in four easy steps Ensure long-term profits with an unblinking buy-and-hold strategy This complete guide shows you why Graham's game-changing formula works and how to use it to build a profitable portfolio. Additionally, you learn tips and proven techniques for unlocking the formula's full potential with disciplined research and emotional control to stick by your decisions through long periods of inactive trading. But even if your trading approach includes profiting from short-term volatility, you can still benefit from the valuation formula and process inside by using them to gain an advantageous perspective on stock prices. Find the companies that will grow you a fortune with Benjamin Graham and the Power of Growth Stocks.

http://www.lybrary.com/benjamin-graham-and-the-power-of-growth-stocks-lost-growth-stock-strategies-from-the-father-of-value-investing-p-125191.html

Speculative-Growth Stocks - Are Net Margins on the Rise?

Although Yahoo is profitable, many speculative growth companies - including most Internet companies - lose money.

Of course, that is to be expected from a new venture.  It's investing heavily to exploit profit opportunities, and if those investments pay off, earnings will materialize.

But to curb risk, we want to find companies that are making progress toward profitability.

Even if a company is losing money, net margins should be improving, even if that means becoming less negative.  

Yahoo shows an encouraging trend in 1999.

• After losing money in its first three years, Yahoo made a profit in 1998, with a net margin close to 5%.  
• Furthermore, it had net margins above 20% in the third and fourth quarters of 1998 and the first quarter of 1999.  
• Net margins declined over the next few quarters because of non-cash charges resulting from mergers, but operating margins (which exclude such charges) remained solid.
• Yahoo appears to have left its money-losing phase behind.

(My comment:  A great company can still be a bad investment if you pay too high a price to own it.)

It's actually growth that determines value. You can't encapsulate the inherent value of a business in a P/E ratio.

Some of the market's biggest winners were trading at prices above 30 times earnings before they made their move.

A stock with a P/E below 10 may be a better deal than another trading at a P/E above 20. But then again it might not. 

The point is, when you become a part owner in a company, you have a claim not just on today's earnings, but all future profits as well. The faster the company is growing, the more that future cash flow stream is worth to shareholders.

That's why Warren Buffett likes to say that "growth and value are joined at the hip."

You can't encapsulate the inherent value of a business in a P/E ratio.  It's actually growth that determines value.  

The PEG ratio is used to evaluate a stock's valuation while taking into account earnings growth. A rule of thumb is that a PEG of 1.0 indicates fair value, less than 1.0 indicates the stock is undervalued, and more than 1.0 indicates it's overvalued.  Here's how it works:

If Stock ABC is trading with a P/E ratio of 25, a value investor might deem it "expensive." But if its earnings growth rate is projected to be 30%, its PEG ratio would be 25 / 30 PEG.83. The PEG ratio says that Stock ABC is undervalued relative to its growth potential.

It is important to realize that relying on one metric alone will almost never give you an accurate measure of value. Being able to use and interprete a number of measures will give you a better idea of the whole picture when evaluating a stock's performance and potential. 

Why We Look at the PEG Ratio

One of the more popular ratios stock analysts look at is the P/E, or price to earnings, ratio. The drawback to a P/E ratio is that it does not account for growth. A low P/E may seem like a positive sign for the stock, but if the company is not growing, its stock's value is also not likely to rise. The PEG ratio solves this problem by including a growth factor into its calculation. PEG is calculated by dividing the stock's P/E ratio by its expected 12 month growth rate. 

How to Score the PEG Ratio
Pass—Give the PEG Ratio a passing score if its value is less than 1.0.
Fail—Give the PEG Ratio a failing score if its value is greater than 1.0.

Wednesday July 18, 2007

Growth versus value investing

Ooi Kok Hwa

Value investing means searching for stocks selling lower than their value, whereas growth investing is finding companies with growth potential. Failure to pay attention to any risk factors may result in unintended losses

Q: Which one provides better return, growth or value investing?

Choosing between growth and value investing is always a tough decision. Value investing is concerned with the current price level and fair price of a stock, while growth investing is more focused on the potential earnings growth of the company.

According to Warren Buffett, the term “value investing” is redundant because “investing” is definitely an act of seeking value, at the very least, sufficient to justify the amount paid. He believes that growth is always a component in the calculation of value. For every dollar used in investing, it must create more than a dollar of long-term market value.

Value investing

The principle behind value investing is using the market approach, which is concerned about the current price level of a stock. Therefore, ratios such as price earnings ratio (PER) and price-to-book are used and special attention is paid to the price component of these ratios.

When using the PER method, a low PER is preferred, as investors believe the current low price level may be due to an overly pessimistic assessment of the company’s future prospects. The PER will eventually revert to its normal market level when other investors realised that prospects are not as bad as they thought.

As a result, they rely on the movement in stock price rather than the earnings. They will search for companies with low PERs, as they expect the ratios to increase to their normal levels with or without an increase in earnings. However, value investors face the risk of misinterpreting a cheapness signal when the market’s concern about the stock may indeed be correct.

Growth investing

This method is based on the earnings potential of a company. By assuming the PER will be constant, investors anticipate that higher growth in earnings will contribute to higher stock prices.

Benjamin Graham, the father of value investing, defined a growth company as one that has performed better than the average company over a period of years and is expected to continue doing so in the future.

Growth investing is a method of identifying companies with average growth prospects. Its focus will be on the potential growth in earnings, which has not yet been reflected in the current stock price.

Here, the key risk is the non-occurrence of the expected growth. In some cases, growth investors may be entirely vindicated in their judgment of the quality of the underlying business, but the stock still performed badly because it was so overly priced at the time of purchase.

In addition, this method assumes a constant PER. If the PER declines for some unanticipated reason, the investors will incur losses as a result of lower stock prices despite a higher growth in earnings.

Buy low, sell high or buy high, sell even higher?

Value investors are always the earlier buyers of stocks. They buy based on the belief that the market has misread the real value of the company. At that moment, the future prospects of the company may still be uncertain; there may or may not be an increase in earnings.

Thus, in addition to using the PER, value investors will use other measures, like dividend yield or price-to-book ratio, to support their purchase decisions.

In contrast, growth investors will come in at the early recovery stages of a company’s fundamentals. At that point in time, the stock’s price will have already moved higher from its recent low. Value investors will usually start to feel uncomfortable with the price level and sell the stock even though the company’s fundamentals have recovered, while growth investors will buy the stock in the belief that they are buying high to sell even higher.

Growth investors believe that it is safer to buy stocks when the fundamentals have shown definite signs of recovery, and will sell higher when the prices increase as a result of further improvement in the companies’ fundamentals.

Hence, both value and growth investing have their strengths and weaknesses. Failure to pay attention to their risk factors may result in unintended losses.

Ooi Kok Hwa is an investment adviser and managing partner of MRR Consulting. He can be contacted at ooi_kok_hwa@hotmail.com.

http://biz.thestar.com.my/news/story.asp?file=/2007/7/18/business/18329841&sec=business

There are many variations on the value investing theme. However described, the fusing theme among value investors is appreciating the difference between stock price and business value.

There are many variations on the value investing theme.  The philosophy permits particular applications that vary to suit individual taste and ability.  Leading value investors employ a range of styles.

Philip Fisher is a good example.  In Fisher's era, investment wealth arose either:

• from traditional value investing (buying underpriced securities and holding them until fairly priced or overpriced) or 
• fairly-priced businesses poised to grow so rapidly in sales and earnings (today we would add cash flows) that profits arise from that growth.  

The former describes traditional Graham-based pure value investing.  The latter is Fisher's pioneering sense as a growth rather than a value investor and leads to the distinction (somewhat false) between the two.

Many contrast Graham, the father of value investing, and Fisher, the father of growth investing.  But because value investing and growth investing are really cousins of one another, Fisher is better understood as developing a variation on value investing's themes.  The difference is more a matter of style and emphasis than fundamentals.

Among the most famous published accounts of success reported by students of Graham-Dodd's teachings is Buffett's essay The Superinvestors of Graham-and-Doddsville.  He documents a range of value investors who adopted varying styles of the philosophy.

• Some diversify investments widely while others allocate wealth to a concentrated group of stocks.  
• Most place a high premium on understanding the particulars of any business before investing, yet some will invest while holding only a reasonable level of expertise on a business.

Columbia University Business School professor Bruce Greenwald published a series of essays updating and elaborating Buffett's Superinvestors theme.  He highlights numerous value investors to underscore slight variations of approach.

• Some refine valuation methods to define value as what informed industrialists would pay to own a business's equivalent assets.  
• Some relate historical price fluctuations to intrinsic business value.
• Others combine this innovation with more traditional valuation metrics to enhance investment discipline.  
• Some emphasize the role of catalysts such as takeovers and bankruptcy reorganizations that can transform underpriced businesses into reliased investment results.

Of the variety of value investors and their styles, those most closely aligned to Graham might be called pure value investors.  Those giving more weight to other traditions or contemporary influences might loosely be described as modified value investors.  

However described, the fusing theme among value investors: 

• is appreciating the difference between stock price and business value.  
• All also believe in the gospel of the margin of safety.  

A common characteristic is superior investment results.

Growth versus Value: Why invest unless you see value?

Growth companies are those that are growing sales and earnings every year.

Value companies are trading at low prices.  These low prices are usually the result of tough times at the company but occasionally just because the market's a weird place.

Often, the best growth investments are smaller companies.

The best value plays are usually large companies.  Not always, but most of the time.


Here are some examples (retrospectively):


Growth companies:  Topglove, Hartalega, Kossan, KNM, Hai-O, Coastal, Latexx, Nestle, Petdag, PPB, etc.


The PEs of growth companies tend to fluctuate hugely.  When the growth slowed or the companies hit a rough patch, the shares of growth companies can fall by a large amount.  Can you spot these companies in the early stages of their growth paths?


Value companies:  Maybank, PBB, LPI, DLady, Guinness, Sime, APM, etc.


Large good companies were selling at bargain prices during the recent global financial crisis in 2008/2009. These companies are "safe" to buy during these periods when they are undervalued.  They usually will rebound during recovery of the market.  Some companies met some headwind or rough patch during their financial year and their share prices were sold down hugely, offering bargain prices for the savvy investors.  Did you spot the values in these times in these stocks?  Did you seize these opportunities or were you seized by fear of loss and the unknown?


The division between growth and value companies is not always clear-cut.  Many can also be classified as stocks that have business growth selling at reasonable prices (GARP).


Another phenomenon to note is that investors tend to invest into value companies when they also starting to show some growth in their business.  Similarly, investors buy into growth companies at the point when they are starting to show some value.  :-)


Therefore, growth and value investings are basically two sides of the same coin.  They are joined at the hip, according to Buffett.  Above all else, why invest unless you see value in either?

Quality Investing

Quality investing
From Wikipedia, the free encyclopedia

Quality investing is an investment strategy based on clearly defined fundamental factors that seeks to identify companies with outstanding quality characteristics. The quality assessment is made based on soft (e.g. management credibility) and hard criteria (e.g. balance sheet stability). Quality Investing supports best overall rather than best-in-class approach as the specific industry’s or country’s quality is evaluated as well.

Contents  [hide] 1 History 2 Identification of Corporate quality 3 Comparison to other investment models 4 References 5 See also

[edit]History

The idea for quality Investing originated in the bond and real estate investing, where both the quality and price of potential investments are determined by ratings and expert attestations. Later the concept was applied to enterprises in equity markets.

Benjamin Graham, the founding father of value investing, was the first to recognize the quality problem among equities back in the 1930s. Graham classified stocks as either quality or Low quality. He also observed that the greatest losses result not from buying quality at an excessively high price, but from buying Low quality at a price that seems good value.^[1]

The quality issue in a corporate context attracted particular attention in the management economics literature following the development of the BCG matrix in 1970. Using the two specific dimensions of life cycle and the experience curve concept, the matrix allocates a company's products – and even companies themselves – to one of two quality classes (Cash Cows and Stars) or two Non-quality classes (question Marks and Dogs). Other important works on quality of corporate business can be found primarily among the US management literature. These include, for example, "In Search of Excellence" by Thomas Peters and Robert Waterman^[2], "Built to Last" by Jim Collins and Jerry Porras^[3], and "Good to Great" by Jim Collins^[4].

Quality Investing gained credence in particular after the burst of Dot-com bubble in 2001 when investors learned of the spectacular failures of companies such as Enron and Worldcom. These corporate collapses focused investors’ awareness of quality from stock to stock. Investors started to pay more attention to quality of balance sheet, earnings quality , information transparency, corporate governance quality.

[edit]Identification of Corporate quality

As a rule, systematic quality investors identify quality stocks using a defined schedule of criteria that they have generally developed themselves and revise continually. Selection criteria that demonstrably influence and/or explain a company's business success or otherwise can be broken down into five categories:^[5]

1. Market Positioning: quality company possesses an economic moat, which distinguishes it from peers and allows to conquer leading market position. The company operates in the industry which offers certain growth potential and has global trends (e.g. ageing population for pharmaceuticals industry) as tailwinds.

2. Business model: According to the BCG matrix, the business model of a quality company is usually classified as star (growing business model, large capex) or cash cow (established business model, ample cash flows, attractive dividend yield). Having a competitive advantage, quality company offers good product portfolio, well-established value chain and wide geographical span.

3. Corporate Governance: Evaluation of corporate management execution is mainly based on soft-criteria assessment. Quality company has professional management, which is limited in headcount (6-8 members in top management) and has a low turnover rate. Its corporate governance structure is transparent, plausible and accordingly organized.

4. Financial Strength: Solid balance sheet, high capital and sales profitability , ability to generate ample cash flows are key attributes of quality company. Quality company tends to demonstrate positive financial momentum for several years in a row. Earnings are of high quality, with operating cash flows exceeding net income, inventories and accounts receivables not growing faster than sales etc.

5. Attractive valuation: Valuation ultimately is related to quality, which is similar to investments in real estate. Attractive valuation, which is defined by high discounted cash flow (DCF), low P/E ratio and P/B ratio, becomes an important factor in quality investing process.

According to a number of studies the company can sustain its quality for about 11 months in average, which means that quantitative and qualitative monitoring of the company is done systematically.

[edit]Comparison to other investment models

Quality investing is an investment style that can be viewed independent of value investing and growth Investing. A quality portfolio may therefore also contain stocks with Growth and Value attributes.

Nowadays, Value Investing is based first and foremost on stock valuation. Certain valuation coefficients, such as the price/earnings and price/book ratios, are key elements here. Value is defined either by valuation level relative to the overall market or to the sector, or as the opposite of Growth. An analysis of the company's fundamentals is therefore secondary. Consequently, a Value investor will buy a company's stock because he believes that it is undervalued and that the company is a good one. A quality investor, meanwhile, will buy a company's stock because it is an excellent company that is also attractively valued.

Modern Growth Investing centers primarily on Growth stocks. The investor's decision rests equally on experts' profit forecasts and the company's earnings per share. Only stocks that are believed to generate high future profits and a strong growth in earnings per share are admitted to a Growth investor's portfolio. The share price at which these anticipated profits are bought, and the fundamental basis for growth, are secondary considerations. Growth investors thus focus on stocks exhibiting strong earnings expansion and high profit expectations, regardless of their valuation. Quality investors, meanwhile, favor stocks whose high earnings growth is rooted in a sound fundamental basis and whose price is justified. (QVM approach)

References

1. ^ Benjamin Graham (1949). The Intelligent Investor , New York: Collins. ISBN 0-06-055566-1.
2. ^ Thomas Peters and Robert Waterman (1982). In Search of Excellence. ISBN 0-06-015042-4
3. ^ Jim Collins and Jerry Porras (1994). Built to Last. ISBN 978-0887307393
4. ^ Jim Collins (2001). Good to Great . ISBN 978-0-06-662099-2
5. ^ Weckherlin, P. / Hepp, M. (2006). Systematische Investments in Corporate Excellence, Verlag Neue Zürcher Zeitung. ISBN 3-03823-278-5.

[edit]See also

• Value investing
• Growth investing

http://en.wikipedia.org/wiki/Quality_investing