Value? Growth? Both!

Red wine or white? Paper or plastic? Value or growth?

Our daily lives are full of choices, and they tend to be presented as though they're either-or. But while you might not want to chat up your boss at the holiday party with a glass of chardonnay in your left hand and a glass of merlot in your right, when it comes to investing, you should definitely imitate your favorite toddler.

Value or growth? Both!

Just say yes
It's true that classic "value" stocks such as Kraft (NYSE: KFT  ) rarely have the rock-star growth of growth stocks, and classic "growth" stocks such as Google (Nasdaq: GOOG  ) rarely look "cheap." But wouldn't you like to have both? The margin of safety that value investing provides, along with the unimaginable upside of a great growth stock?

There are two reasons why you shouldn't have to choose.

For starters, it's a false dichotomy
The distinction between value and growth stocks is such a bedrock assumption that Morningstar routinely classifies stocks, mutual funds, and ETFs as one or the other -- and many funds and ETFs follow suit.

The iShares Russell 1000 Value Index (IWD), for instance, features such stalwarts as ExxonMobil (NYSE: XOM  ) , Procter & Gamble (NYSE: PG  ) , and Coca-Cola (NYSE: KO  ) .

Its growth compatriot, the iShares Russell 1000 Growth Index (IWF), on the other hand, features in its top holdings companies such as … ExxonMobil, Procter & Gamble, and Coca-Cola.

Huh?

This just goes to show that the same company can be both a growth and a value stock. Value investing, after all, wants to buy companies selling at a discount to their intrinsic value. Growth investing wants to buy companies that will grow their bottom lines -- and presumably your investment -- many times over. But there's nothing excluding fast-growing stocks from being undervalued. That's why Warren Buffett himself said that "growth and value investing are joined at the hip."

Putting the puzzle together
The other piece that gets lost in the "value vs. growth" debate is this: You shouldn't be buying only one stock anyway. You should be building a portfolio. And that portfolio should be -- say it with me now -- diversified.

One premise of diversification is that different kinds of stocks do better in different market environments. Putting together assets that don't move in the same direction at the same time will create the best chance for high returns with lower overall volatility. Notice how each of these different investment classes go into and out of fashion at different times:

Year

Large Caps

Small Caps

International

REITs

1972-1979

5.1%

19.5%

11.1%

10.5%

1980-1989

17.5%

17.0%

22.8%

15.6%

1990-1999

18.2%

16.8%

7.3%

9.1%

2000-2008

(3.8%)

3.9%

(1.2%)

7.7%

Sources: Ibbotson Associates, Morgan Stanley EAFE Index, NAREIT Index.

So when you're picking stocks, make sure you choose from a variety of categories:

  • Large-cap stocks, being more established, typically endure less volatility; small-cap stocks, on the other hand, are more risky but also have the potential to be more rewarding.
  • Value stocks provide downside protection and a reasonable assumption of an upside, while growth stocks take advantage of room to double, triple, and quadruple in value.
  • Domestic stocks take advantage of the unparalleled power of American industry -- but emerging economies, which don't always move in lockstep with developed economies, have room to grow much faster than ours.
  • While they have may have a reputation for being slow growers, dividend payers have historically boosted performance for investors: From 1960 to 2005, about 80% of the market's returns came from reinvested dividends.
  • Diversifying across industries ensures that your portfolio isn't wiped out from unforeseen economic, political, or natural disasters. While the credit crisis bankrupted numerous financials and pushed department store stocks down an average of 64% in 2008, discount stores, biotech, and waste management have held their own.

Your portfolio should have all of these: large caps and small, value stocks and growth, domestic stocks and international, as well as some dividend payers -- all from a variety of industries.

Whoa -- how many stocks are we talking here?
It won't necessarily take dozens of stocks to diversify in all of these ways, because, as I mentioned earlier, the same stock can fit into multiple categories.

Take "technology, media, and financial services company" General Electric (NYSE: GE  ) as an example. Where would it fit on this list? It has a market cap of $170 billion, Morningstar considers it a value stock, it currently yields 7.9%, and while it's based in Connecticut, half of its revenue comes from outside the United States.

Or what about tiny China Fire & Security (Nasdaq: CFSG  ) ? It's a $190 million growth company selling fire-protection products to Chinese corporations.

Every single stock you consider is going to fit many different categories, and thus will diversify your portfolio in multiple ways. The key is to fit your holdings together to achieve meaningful diversification, so that you can enjoy strong returns with minimal risk.

The Foolish bottom line
As important as diversification is, it's secondary to buying stocks worth holding for the long run. But as you consider the world of stocks worth holding, you want to make sure you're blending them together for a portfolio that can earn you great returns while weathering all kinds of markets.

In their new book, The Motley Fool Million Dollar Portfolio, Motley Fool co-founders David and Tom Gardner not only show you how to invest in different kinds of stocks, but they also teach you how to put them together for a portfolio that wins over the long haul. Interested in finding out what they recommend? Click right here to learn more.

At the time of publication, Fool editor Julie Clarenbach owned none of the securities mentioned in this article. Morningstar is a Stock Advisor selection and a Fool holding. Coca-Cola is a Motley Fool Inside Value recommendation. Kraft is an Income Investor choice. Google is a Rule Breakers pick. China Fire & Security is a Global Gains selection. The Motley Fool's disclosure policy likes to read.


Read/Post Comments (5) | Recommend This Article (72)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On January 04, 2009, at 4:32 PM, FinancialFellow wrote:

    It's good to see mention of diversifying through REITs again. Ever since the housing bubble burst REITs rarely get mentioned anymore. But, I would agree that over the long term it is important to invest in REITs to diversify your portfolio - along with value and growth stocks. I don't hear of many 401k plans offering REITs, though. I suspect for many people if you want to invest in REITs (from a retirement savings point of view) you have to go through your IRA. I'd be curious to hear from anyone that has a company sponsored 401k plan that offers REITs as an option though.

    One area that may also be worth exploring is investing in banks. Although it is a highly risky time bank stocks are certainly a bargain at this point - assuming the stocks you invest in don't eventually fail. Here's an interesting list I came across lately of the actual names of banks that are near collapse: http://financialfellow.com/2008/12/31/names-of-banks-near-co...

  • Report this Comment On January 08, 2009, at 11:46 AM, jjeejjee51 wrote:

    Sorry this is off the subject, but I just ordered your new book 'How to biuld a million dollar... . I saw no indication on the amazon.com page that I would receive the free book about 2009 stock picks. Will it automatically be shipped with the order?

    Thanks, jekjek@cfl.rr.com

  • Report this Comment On January 08, 2009, at 3:37 PM, Mthirsty1 wrote:

    I just received my book in the mail and the only thing in the package was the book.So my question is the same as jekjek.

  • Report this Comment On January 10, 2009, at 12:56 AM, Rone222 wrote:

    I wrote to MF about the same questions Mthirsty1 and jerkjek are aksing and they e-mailed me the links for the promised bonus material.

    Hey MF why not get a clear link going for those who buy your book?

  • Report this Comment On January 10, 2009, at 7:58 AM, RayBrown3 wrote:

    If this is a couple's or individual's portfolio, I think the composition also depends on their age and goals. Trying to keep a balanced, diversified, risk-adjusted, age appropriate, goal centered, and market driven portfolio is hard work.

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