There are many different ways to be a successful investor, and many people have fundamentally different ways in which they seek out the stocks they think will do best. One particularly wide gulf within the investment community is between value investors and growth investors. Listening to the debate between the two groups, you'd think that there'd be a clear-cut answer to which strategy is superior. Yet in the end, a lot depends on how you define investment success -- particularly where your tolerance for risk lies in pursuit of the best possible return.
Two investing camps
One difficulty in comparing the two strategies stems from the fact that there's no perfect definition for what value investing and growth investing are. In general, though, most people believe that value investing hinges on the idea that the best stocks in which to invest are those whose current share price doesn't accurately reflect the full potential that the company has to produce future income and growth. Many value investors focus on stocks that have seen their share prices beaten down substantially, believing that in many cases, shareholder panic in such situations is overblown. Others tend to define value stocks simply as the opposite of growth stocks, essentially relegating all companies with below-average growth rates to the value stock bin.
Growth investing, on the other hand, is a little bit easier to recognize. Growth investors like to buy stocks that are seeing the biggest gains in revenue or net profits. Some growth investors focus on early stage small-cap companies that often haven't even become sustainably profitable yet, seeking out the highest sales growth in the belief that eventually, earnings will follow. Other investors look for better-established growth stocks that are already solidly in the black yet have further chances to expand their reach.
How have both strategies done recently?
When you look over the past 10 years at how value and growth stocks have done, it isn't even close. Growth has dominated value, with the iShares Russell 1000 Growth ETF (NYSEMKT:IWF) producing total returns of 174% since 2008, compared to just 100% over the same 10-year period for the iShares Russell 1000 Value ETF (NYSEMKT:IWD). Using other fund families to compare leads to similar results. For instance, comparing two major growth and value ETFs from Vanguard, growth beats value 163% to 117%.
However, there are trade-offs when you go with growth. The thing about growth stocks is that they often underperform during bear markets, just as they outperform during bull markets. For instance, between mid-2000 and the beginning of 2003, the iShares growth ETF fell more than 50%, compared to just a 14% drop for the iShares value ETF.
Over the longer-term history of the stock market, value stocks have had an edge. From 1926 to 2016, value stocks returned an average of 17% annually, compared to 12.6% for growth stocks. Interestingly, the survey found that value stocks tend to do better when the economy turns around, but worse when the economy is weakening.
Indeed, value stocks aren't always invulnerable to downturns. Between the market highs in the fall of 2007 and the bottom of the financial crisis bear market in early 2009, both growth and value stocks took huge hits. In fact, value stocks underperformed, with losses of 51% compared to 43% losses for growth stocks. That was due largely to the fact that banking stocks generally qualify as value rather than growth stocks, and they were among the hardest hit during the financial crisis.
Which strategy should you pick?
Most investors find that they simply like one style of investing better than the other, and you should generally go with that preference in making individual stock selections. You'll do a better job of picking stocks if you're passionate and motivated to look at the companies you want to invest in. So if cutting-edge growth stocks interest you, go with that. If you prefer well-known companies and think you can pick the ones that will rise from the ashes, that can serve you well too.
Yet more importantly, don't fall into the trap of thinking that either strategy is the end-all be-all solution. The best stocks combine both growth and value, trading at a reasonable price compared to their impressive growth potential. When you find the best of growth and value in a single stock, that's usually a good sign that you've discovered a great investment.