Should you be investing in growth stocks or value stocks? While it depends on what you're looking for from your investments, it also goes to the core of who you are as an investor. Here, Rick Munarriz, head scout for early adopters in Rule Breakers, lays out his argument for growth, then Philip Durell, investment analyst for Inside Value, takes his turn at the plate. When you're finished reading both sides, visit ourDueling Fools discussion board to tell us what you think.
Floors? Or ceilings? No, this isn't some twisted home decorating version of Chutes and Ladders. It's a question that every investor -- including you -- should consider before taking that next step in the market. It's just too easy to throw around investing labels such as "Value" and "Growth." Both are savory propositions. Who wouldn't want to buy something at a conventionally cheap price? Who wouldn't want to buy into a company ready to aggressively and ambitiously kick it up a notch?
That's why I prefer to compare the growth and value philosophies to floors and ceilings. While a skilled value investor will buy into companies with a thorough understanding of the stock's downside -- its floor -- the adept growth seeker will buy in with a thorough appreciation of the stock's potential upside -- its ceiling.
Floss, then brush, or brush, then floss?When you step foot into a stock for the first time, do you notice the quality of the floor's foundation, or are you simply more captivated by the vaulted ceiling? I can tell you how Rule Breakers do it. Sometimes our necks flat-out ache because we've been staring at the seemingly limitless sky.
You can draw this analogy to its cautionary conclusion. It's easy to stumble when you're not looking down. I'm sure Philip will present a wonderful case for Inside Value. I just sometimes find myself unable to look down because I don't want to miss a thing.
Pull over, Value; let me pass
Floors and ceiling are tangible, but you want something more to sink your teeth into. I hear you. Let me drum up Apple Computer (NASDAQ:AAPL) to illustrate why I believe Rule Breakers are better.
Two years ago, a value investor could have been easily won over by the company. The stock was at $15 and the company had a sparkling balance sheet with roughly $10 a share in cash and short-term investments. While its market share in the personal computer space had dwindled over the years, it was serving a loyal user base and that was unlikely to go away.
Philip's newsletter service aims the crosshairs at stalwarts, turnarounds, and cyclicals, and it would be easy to argue that Apple was a stalwart with the mother of all cash mattresses ready to break any potential fall. In other words, it was a worthy stalwart with a respectable margin of safety.
Fiscal 2003 wasn't much to write home about. Sales did inch higher, while earnings came in essentially flat, tailing off by year's end. A closer look would have revealed that if it weren't for the substantial interest income and one-time gains that Apple generated, it would have actually posted a loss on the year. Yet the stock proved to be resilient by climbing 49% higher in 2003.
Levitating off the floor, with its share price now fetching twice as much as its balance sheet greenery, a true value investor would have probably bowed out. The margin of safety wasn't there. The company's business plan was starting to stray from the familiar.
Value investors may have moved on, but Rule Breakers were probably rounding the wagons. Apple was defying conventional wisdom with its iPod portable music players and stylish new desktop and laptop computers. After the five major record labels failed in winning over consumers with their digital music services, Apple marched in and won the masses over with its iTunes downloading service. Yes, the loyal Mac-loving crowd never left, but now Apple was commanding a much wider audience. As the year progressed, Apple found itself selling more iPods than Macs. How did the stock do through this defiant Rule Breaker spurt in the company's colorful history? It more than tripled in 2004.
More than Apple
Value investors analyze yesterdays. Growth investors speculate on tomorrows. While that does not necessarily excuse a company from jumping through the appropriate fundamental gauges, the workout just isn't as rigorous for the growth camp. It's more about vision and concepts.
Consider eBay (NASDAQ:EBAY). I can't think of a single person who could argue that eBay has ever been fundamentally undervalued using traditional value investing benchmarks. Benjamin Graham would have simply shrugged. Yet what has the stock done? It has taken off like a rocket. The shares have tripled over the past three years alone.
eBay was one of the many great growth stocks that the original Rule Breakers portfolio rode toward market-thumping gains even as value-minded pundits shouted "overvalued" at every turn.
The same can be said for the whopping 2,418% gain that Rule Breakers scored by buying America Online shares early in the consumer adoption phase. What about a 576% spike while holding Amazon (NASDAQ:AMZN) or a welcome 150% return on Amgen (NASDAQ:AMGN)? It all came to be.
None of those winning stocks were purchased at their lows. None of those sumptuous gains were achieved by waiting for attractive valuation multiples. Nice floor? I'm sorry, I was too busy marveling at the cathedral ceilings to notice.
Risk's rewards
Is trolling for Rule Breakers a riskier pastime than angling for Inside Value situations? You bet. Volatility is a given. Yet all it takes is one 10-bagger to offset nine other worst-case scenario duds that freefall to nil. That's why growth stock investing is so potent. It's all about the slugging percentage, as you virtually swing for the fences in this brave new economy.
Right now, I can assure you that someone is baffled at how a money-losing upstart like Sirius Satellite Radio (NASDAQ:SIRI) can consistently dominate the most actively traded stock tables or how a simple online retailing concept like recent Rule Breakers recommendation Overstock.com (NASDAQ:OSTK) can continue to appreciate.
A cynic would note that the only gauges that some growth stocks appear cheap in would be price-to-hype or price-to-story stock multiples. Yet if the past is any indication, quite often that hype -- that scintillating story -- winds up undershooting the ultimately grand reality.
So tap shoes or a jet pack? At Rule Breakers, we'll be shooting for the sky.
Longtime Fool contributor Rick Munarriz does not own shares in any of the companies mentioned in this story. He is a member of theRule Breakersanalytical team, seeking out the next great growth stock early in its stage of defiance. The Motley Fool is investors writing for investors.
