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. 




Growth companies: 

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: 

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 investing 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?

"Gentlemen who prefer bonds don't know what they've missing."

Theoretically, it makes no sense to put any money into bonds, even if you do need income.

Take the case of a asset allocation of 50 percent of the money invested in stocks that grow at 8% and 50 percent in bonds that don't appreciate at all, the combined portfolio had a growth rate of 4 percent - barely enough to keep up with inflation.

What would happen if we adjusted the mix?

By owning more stocks and fewer bonds, you would sacrifice some current income in the first few years.  But this short-term sacrifice would be more than made up for by the long-term increase in the value of the stocks, as well as by the increases in dividends from those stocks.  

Since dividends continue to grow, eventually a portfolio of stocks will produce more income than a fixed yield from a portfolio of bonds. 

Peter Lynch



Additional notes:

1.  Once and for all, we have put to rest the last remaining justification for preferring bonds to stocks - that you can't afford the loss in income.
2.  But here again, the fear factor comes into play.
3.  Stock prices do not go up in orderly fashion, 8 percent a year.  Many years, they even go down.
4.  The person who uses stocks as substitute for bonds not only must ride out the periodic corrections, but also must be prepared to sell shares, sometimes at depressed prices, when he or she dips into capital to supplement the dividend.
5.  This is especially difficult in the early stages, when a setback for stocks could cause the value of the portfolio to drop below the price you paid for it.
6.  People continue to worry that the minute they commit to stocks, another BIG ONE will wipe out their capital, which they can't afford to lose.
7.  This is the worry that will keep you in bonds, even after you've studied and are convinced of the long-range wisdom of committing 100% of your money to stocks.


Let's assume, that the day after you've bought all your stocks, the market has a major correction and your portfolio loses 25% of its value overnight.
1.  You berate yourself for gambling away the family nest egg, but as long as you don't sell, you're still better off than if you had bought a bond.
2.  Computer run simulation shows that 20 years later, your portfolio will be worth $185,350 or nearly double the value of your erstwhile $100,000 bond.

Or, let's imagine an even worse case:  a severe recession that lasts 20 years, when instead of dividends and stock prices increasing at the normal 8 percent rate, they do only half that well.
1.  This would be the most prolonged disaster in modern finance.
2.  But, if you stuck with the all-stock portfolio, taking out your $7,000 a year, in the end you'd have $100,000.  This still equals owning a $100,000 bond.

Ref:  Pg 55 Beating the Street, by Peter Lynch.


FOR YOUR IMMEDIATE ACTION!!!

1.  TALK YOURSELF OUT OF OWNING ANY BONDS.
2.  AT LEAST, YOU SHOULD DECIDE TO INCREASE THE PERCENTAGE OF ASSETS INVESTED IN STOCKS, WHICH IS A STEP IN THE RIGHT DIRECTION.

How does the bear market affect my investments?

Generally, a bear market will cause the securities you already own to become undervalued. The decline in their value may be sudden, or it may be prolonged over the course of time, but the end result is the same: What you already own is worth less [according to the market.] 


This leads to two fundamental truths: 
1.) A bear market is only bad if you plan on selling your stock or need your money immediately. 
2.) Falling stock prices and depressed markets are the friends of the long-term investor. 

In other words, if you invest with the intent to hold your investments for years down the road, a bear market is a great opportunity to buy. [It always amazes me that the "experts" advocate selling after the market has fallen. The time to sell was before your stocks lost value. If they know everything about your money, why they didn't warn you the crash was coming in the first place?] 


So what do I do with my money in a bear market? 

The first thing you need to do is to look for companies and funds that are going to be fine ten or twenty years down the road. If the market crashed tomorrow and caused Gillette's stock price to fall 30%, people are still going to buy razors. The basics of the business haven't changed. 


This proves the third fundamental truth of the market: 

3.) You must learn to separate the stock price from the underlying business. They have very little to do with each other over the short-term. 

When you understand this, you will see falling stock markets like a clearance sale at your favorite furniture store... load up on it while you can, because before long, the prices will go back up to normal levels.

This Expert Called the Market Plunge. Here’s What He Sees in 2019.

The New York Stock Exchange last month, the worst December for stocks since 1931. James Stack, president of InvesTech Research, is anticipating a bear market.CreditHiroko Masuike/The New York Times

Image

The New York Stock Exchange last month, the worst December for stocks since 1931. James Stack, president of InvesTech Research, is anticipating a bear market.CreditCreditHiroko Masuike/The New York Times

By James B. Stewart

• Jan. 4, 2019

A year ago, in the wake of President Trump’s tax cut, euphoric investors pushed the Dow Jones industrial average past 25,000, a record. The Dow had just gained 25 percent in 2017, and the Nasdaq had leapt 28 percent. Volatility was so low that there wasn’t a single day in 2017 when the S&P 500 fluctuated more than 2 percent.

Not everyone was celebrating.

“If there are any certainties, one will be that this party will eventually come to an end,” James Stack, president of InvesTech Research, told me a year ago. “And when it ends, it will end badly, and with high volatility.”

Mr. Stack turned out to be right. He lowered his recommended asset allocation for United States stocks from 82 percent last January to 72 percent in September, when stocks hit new all-time highs. He urged investors to raise cash in October, and at the end of November he recommended an even more defensive posture — including putting money in a fund whose value would rise when stock prices dropped. That brought his recommended net exposure to stocks to just 55 percent, the lowest since the depths of the last bear market in early 2009.

Stocks plunged in December, posting their worst monthly loss since the financial crisis and the worst December since 1931 and the Great Depression.

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Yet most economic indicators are benign. Unemployment is an exceptionally low 3.7 percent. Wages are rising. Inflation remains below the Federal Reserve’s 2 percent target. The Fed raised rates a quarter point in December, citing “a very healthy economy.”

Given Mr. Stack’s track record last year, I reached out to him this week for his current views. Even though valuations have come down and macroeconomic indicators “have remained remarkably strong,” he said, he’s still defensive and hasn’t changed his bearish allocation. He believes that the worst isn’t over and that the Dow and S&P 500 will soon be down 20 percent from their peaks, retreating into a bear market. (The Nasdaq Composite and the Wilshire 2000 index of small-cap stocks are already there.)

And that was before a revenue warning from Apple sent markets into another steep fall on Thursday.

“A lesson from history is that the market leads the economy by a lot longer than investors realize,” Mr. Stack said. If the economy is headed toward recession, as the latest stock market declines suggest it may be, “we won’t see the first economic warning signs until the first three to five months” of 2019. Among the leading indicators he’s watching for signs of weakness are consumer confidence, housing starts and unemployment claims.

On Thursday, the Institute for Supply Management manufacturing index, a leading indicator of industrial activity, fell sharply. That suggests that “serious cracks” are starting to appear in the economy, Mr. Stack said.

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Mr. Stack is right that bear markets typically precede recessions by many months: CNBC calculated in 2016 that bear markets since World War II had begun on average about eight months before a recession. That means that if a bear market did begin after major indexes peaked last fall, a recession might not start until June or even later. Even then, recessions are often over before economic data confirms their existence.

That’s when bear markets are, in fact, followed by recessions, which often isn’t the case. As the economist Paul Samuelson famously said, “The stock market has forecast nine of the last five recessions.”

Since World War II, there have been 13 bear markets. They were followed within a year by a recession just seven times. As a predictor of recessions with just 54 percent accuracy, bear markets are little better than flipping a coin.

Indeed, Mr. Stack’s data show that two down years in a row are quite rare: There have been only four instances since 1928, suggesting that stocks may well be in positive territory by the end of 2019, even if a bear market does materialize in the meantime.

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Which is one reason the Wharton economist Jeremy Siegel told me that he’s bullish on the stock market this year. He predicts it could rise between 5 percent and 15 percent, even if there is an economic slowdown.

Stocks are much cheaper now than they were before the December sell-off. The ratio between stock prices and projected earnings for companies in the S&P 500 is about 17, down from over 19 a year ago and the lowest in the past five years.

[Stocks rose Friday after the release of a strong December jobs report and comments by the chairman of the Federal Reserve that the central bank would be flexible on raising interest rates this year.]

Mr. Stack, however, argued that in the event of an economic downturn — or even a significant slowdown — “those projected earnings will go out the window.”

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“I would not call today’s market undervalued,” he added.

Mr. Siegel bases his forecast of a market rally on the belief that the Fed will stop raising short-term interest rates. “I think the Fed got the message from the markets that it should not have hiked in December,” he said.

Mr. Stack, too, said he was surprised the Fed raised rates in December. “I think the Fed will stand down and put future rate increases on hold,” he said, “which could stabilize the market, at least for the time being.”

But Mr. Stack’s technical indicators are still pointing toward a bear market. He’s also worried about the shaky housing market, with price drops and slowing sales showing up in major cities.

“We’re not trying to time the market, but we’re very comfortable with our defensive allocation,” he said. Although he predicted higher volatility a year ago, he was nonetheless surprised by the extremes reached in December, without even “a single hard warning sign of recession on the horizon.”

“Can you imagine,” he asked, “how volatile it will be when we do have those warnings?”

https://www.nytimes.com/2019/01/04/business/market-forecast-2019.html

What is a bear market and what causes them?

By definition, a bear market is when the stock market falls for a prolonged period of time, usually by twenty percent or more. It is the opposite of a bull market. This sharp decline in stock prices is normally due to a decrease in corporate profits, or a correction of overvaluation [i.e., stocks were way too expensive and needed to fall to more reasonable levels]. Investors who are scared by these lower earnings or lofty valuations sell their stock - causing the price to drop. This causes other investors to worry about losing the money they've invested, so they sell as well... and the vicious cycle begins.

One of the best examples of such an unfriendly market is the 1970's, when stocks went sideways for well over a decade. Experiences such as these are generally what scare would-be investors away from investing [which, ironically, keeps the bear market alive... since there are no buyers purchasing investments, the selling continues.]


How do they affect my investments?

Generally, a bear market will cause the securities you already own to become undervalued. The decline in their value may be sudden, or it may be prolonged over the course of time, but the end result is the same: What you already own is worth less [according to the market.]


This leads to two fundamental truths:
1.) A bear market is only bad if you plan on selling your stock or need your money immediately.
2.) Falling stock prices and depressed markets are the friends of the long-term investor.

In other words, if you invest with the intent to hold your investments for years down the road, a bear market is a great opportunity to buy. [It always amazes me that the "experts" advocate selling after the market has fallen. The time to sell was before your stocks lost value. If they know everything about your money, why they didn't warn you the crash was coming in the first place?]


So what do I do with my money in a bear market?

The first thing you need to do is to look for companies and funds that are going to be fine ten or twenty years down the road. If the market crashed tomorrow and caused Gillette's stock price to fall 30%, people are still going to buy razors. The basics of the business haven't changed.


This proves the third fundamental truth of the market:
3.) You must learn to separate the stock price from the underlying business. They have very little to do with each other over the short-term.
When you understand this, you will see falling stock markets like a clearance sale at your favorite furniture store... load up on it while you can, because before long, the prices will go back up to normal levels.




Additional notes:

Fear Index

What are you doing with your money?

-  I'm buying stocks while they are cheap.
-  I'm staying put in the market for the long-term.
-  I'm taking some money out of stocks. I don't want to risk everything.
-  I'm selling all stocks and moving to CDs.
-  I'm in a panic. Where's the nearest mattress?

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VALUE OF AN ASSET

From The Essays of Warren Buffett: “In Theory of Investment Value, written over 50 years ago, John Burr Williams set forth the equation for value, which we condense here: The value of any stock, bond or business today is determined by the cash inflows and outflows—discounted at an appropriate interest rate—that can be expected to occur during the lifetime of the asset.”

My Investing Philosophy

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1.8.2008

My first article in this blog

https://myinvestingnotes.blogspot.com/2008/08/investment-policies-based-on-benjamin.html

FRIDAY, 1 AUGUST 2008

Investment Policies (Based on Benjamin Graham)

Summary of Investment Policies

A. INVESTMENT FOR FIXED INCOME:
US Savings Bonds (FDs or Amanah Sahams for Malaysians)

B. INVESTMENT FOR INCOME, MODERATE LONG-TERM APPRECIATION AND PROTECTION AGAINST INFLATION:
(1) INVESTMENT FUNDS bought at reasonable price.
(2) Diversified list of primary common stocks (BLUE CHIPS) bought at reasonable price. 

C. INVESTMENT CHIEFLY FOR PROFIT: 4 approaches are open to both the small and the large investors:
(1) Representative common stocks bought when the MARKET level is clearly LOW.
(2) GROWTH STOCKS, when these can be obtained at reasonable prices in relation to actual accomplishment – GROWTH INVESTING.
(3) Purchase of securities selling well BELOW INTRINSIC VALUE – VALUE INVESTING.
(4) Purchase of WELL-SECURED PRIVILEGED SENIOR ISSUES (bonds and preferred shares).
(5) SPECIAL SITUATIONS: Mergers, arbitrages, cash pay-outs.

D. SPECULATION:
(1) Buying stock in new or virtually new ventures (IPOs) .(2) TRADING in the market.
(3) Purchase of "GROWTH STOCKS" at GENEROUS PRICES.