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 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 Intel (NYSE: INTC  ) .

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 Intel.

Huh?

This just goes to show that the same company can be both a growth and a value stock. Value investors, after all, want to buy companies selling at a discount to their intrinsic value. Growth investors want 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
What 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 play in lockstep with developed economies, have room to grow much faster than ours.
  • Diversifying across industries ensures that your portfolio isn't wiped out by 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 diversified snack and beverage retailer PepsiCo (NYSE: PEP  ) as an example. Where would it fit on this list? It has a market cap of $97 billion, Morningstar considers it a "core" stock, it currently yields 2.9%, and while it's based in New York, nearly half of its revenue comes from outside the United States.

Or what about China Fire & Security (Nasdaq: CFSG  ) ? It's a $504 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.

Choosing great stocks and fitting them together well is what we're all about at Million Dollar Portfolio, where we invest real money alongside our members. We're beating the S&P 500 -- despite the market volatility. If you'd like to find out more, just click here and enter your email on the next page.

At the time of publication, Fool editor Julie Clarenbach owned none of the securities mentioned in this article. Procter & Gamble and PepsiCo are Motley Fool Income Investor choices. Intel is an Inside Value selection. Google is a Rule Breakers pick. China Fire & Security is a Global Gains recommendation. The Motley Fool owns shares of Procter & Gamble. The Fool's disclosure policy likes to read.


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  • Report this Comment On October 18, 2009, at 7:02 AM, ozzfan1317 wrote:

    Pepsi is a good company and a decent stock however I think KO Is a better investment.

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