Every once in a while, we’ll get a message from a potential subscriber asking how it is that we can have different newsletters that use different investing styles. When we’re trying to explain, we have a maxim that we sometimes cite. The maxim is, “You can make money in any proven investment system if you follow the rules.”
This isn’t an easy idea to explain, but I’ll take a run at it.
And if you’re a new, or even just a potential individual stock investor, this topic should be of interest to you. The big divide in buying individual stocks is between the growth investing style and value investing style.
Both growth and value investors are looking to buy stocks and then sell them for more than they paid. But they go about it in different ways.
In general, growth investors buy stocks of companies that are expected to achieve higher earnings in the future. They often buy stocks whose prices are already rising. They aim to ride the rising stock price until it tops out and then sell it. Growth investors typically own a stock for less than a year, although there are exceptions.
Value investors use a strategy that involves less risk than growth investing, but more time. The value style involves calculating a company’s intrinsic worth, then buying the stock at as big a discount to that worth as possible. Value investors buy undervalued stocks and then sell them when they appreciate to the point that they’re fairly valued. They expect this process to take a long time, as much as three to five years.
As a rule, growth investors tend to be willing to accept more risk than value investors. Growth stocks exhibit higher volatility (price swings) than value stocks, and a piece of bad news (a disappointing earnings report, for instance) can take a growth stock off at the knees, sometimes even at the hips. As in a poker game, growth investors have to be prepared to take a big beat every so often.
A value investor hopes to avoid big beats, often by buying stocks that are already beaten down. Value investors get interested when companies with sound business models and good revenue and earnings prospects fall out of favor for some temporary reason.
Both growth and value investors can be mild or extreme in their style. The most aggressive growth investors are day traders and swing traders who try to ride the daily fluctuations of stock prices. On the milder end, there are growth investors who share value investors’ enthusiasm for forecasting future earnings.
The most extreme value investors look for “fallen angels,” once-loved companies that have fallen on hard times and are facing a long, hard slog before they get back on their feet.
The growth/value dichotomy leaves out strategies like income investing, in which investors buy dividend-paying stocks and look to hold them indefinitely for the cash flow they produce.
And options … well options add a whole new dimension to the game that can’t really be explained in a few sentences.
But the big growth/value distinction is important for new investors because an investing style really has to be in sync with your investing personality if it’s going to work in the long run.
If you’re going to be a good growth investor, you’re going to need discipline, because knowing how to sell quickly and avoid big losses is a prime attribute for great growth investing. And you’ll need a relatively strong stomach and self-confidence to keep you on track when the inevitable bad stock hits.
If you’re going to be a good value investor, you will need patience, because once you’ve done the research, you can’t jump out of a stock just because it’s not moving up.
For new and prospective investors, a little time spent figuring out which style fits your temperament can make a huge contribution to your satisfaction with the outcome.
Cabot has newsletters that appeal to just about any investing personality, and we have a quiz on the front page of our website to help you get the right one for you.
Personally, I like a little more action, so the aggressive growth stance of the Cabot China & Emerging Markets Report (which I write) fits me to a T. Good thing, too, because if I had to do the labor-intensive calculating and projecting that makes for a good value investor, I’d be up a stump.
If you like your stock market action with a little more hot sauce in it, you should check out the Cabot China & Emerging Markets Report. After a long time in the doldrums, things are just starting to heat up in the fast-growing developing markets around the world. Give it a try … but only if it fits your investing personality.
[...] I talked about the difference between value investing and growth investing, and why it’s important to invest in a way that’s consistent with your investing [...]