During the 1990s, growth stocks were all the rage. You could double your money every year, it seemed. Unless you exited near the top in early 2000, though, you probably lost money when they stopped growing and Wall Street realized the "new economy" wasn't so new after all. The result was -- how shall I put it -- not pretty.
At the same time, value stocks were in disfavor. After the bubble popped, people realized that buying the soup du jour probably doesn't always pay, and value investing came roaring back. But value had been there all the time, steadily plodding along.
Fellow Fool Bill Barker recently wrote an article looking at how well growth and value stocks have done historically. His conclusion was that value outlasted growth.
Growth as a component of value
As we investors plod through the universe of available securities and seek to find values or the next big growth stock, a significant question becomes: What defines growth or value, and is there a noted difference as it relates to choosing stocks? According to Bill's article, "Those that are overpriced (growth) will be more overpriced than their large-cap brethren, and those that are underpriced (value) will be more so than their large-cap cousins." But earlier he pointed out, "There's never been an official ruling on what separates 'value' from 'growth.' There are dozens of ways to make those distinctions...."
Consider the following. In Value Investing with the Masters, Kirk Kazanjian interviewed 20 very successful fund managers such as Bill Miller of Legg Mason and William Nygren of Oakmark Funds. These managers have earned 15% to 20% annually for the last 10 or 20 years. Their returns trounce the market, so when they speak, I listen.
In many of the interviews, the conversation turned to a discussion of value versus growth. In nearly every case, statements similar to "it doesn't matter" or "there is no real difference" were made. Several pointed out that growth is a component of value.
In other words, it might stand to reason that there is no real distinction; growth and value are two different aspects that can describe a stock, and likely coexist in some capacity. The extent to which one is emphasized is more a matter of perception and expectation.
Today's price based on current events
To estimate what a company's price should be, you analyze the company, look at what it has been doing, estimate its future prospects, including growth, and assign a value. Depending on what is currently happening with the stock, you assign it different expectations and perceive it as either a growth or a value stock. However, it can be both.
Both Joel Greenblatt and Peter Lynch have written that over the course of a year, a company's stock price can move a lot. Heck, you only have to look at the 52-week highs and lows to see that. If a company swings from $30 down to $15 or up to $45 over the course of the year, does that mean the company is really worth so much more at one point compared with another a short time away? I'm inclined to say that's usually not the case. Unless something odd is going on, it takes a lot longer, with a lot more effort, to change a company's underlying worth by so much.
Realize, though, that most short-term price movements are based more on perception than actual worth -- because it generally takes some time for the actual worth of a given company to be borne out. A company is perceived to have different values over the course of the year, mostly from short-term data such as making or missing an earnings estimate. That doesn't mean the underlying worth of the company has changed very much.
What does not make sense to me is playing the short-term price movement game, because a concrete picture of long-term prospects is hard to see across a limited time horizon. More often than not, that game amounts to guessing at psychology. Even when the news is accurate over the long term, investors' expectations or perceptions often cause overreactions over the short term. And while such a game can work in the short term, it can also prove disastrous in the long term. Remember the tech bubble? Maybe Hari Seldon could predict the actions of whole populations in Isaac Asimov's Foundation series, but I cannot. Will the price go up or down? Yes.
Buying value
Both types of investors would agree that when a company's stock falls below a reasonable estimate of its worth, it's time to buy. How that translates into practice depends on their expectations.
Companies generally perceived as value stocks might have been walloped, might be turnarounds, or may have simply fallen out of favor. Because they're beaten down to begin with, it's generally safe to say they come with low expectations; many investors would contend that they also bear little risk of disappointment. Growth companies, by contrast, generally carry much higher expectations on a given valuation, but possess the sort of market-walloping potential that promises to justify their prices. Though these companies are often eyeing great futures -- better futures, growth investors contend, than the market believes -- their high potential is often priced into their stocks, implying a greater potential downside to accompany the hoped-for upside. Both strategies seek to find undervalued securities; the point of division becomes one of risk tolerance.
I recently bought SyneronMedical
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Fool contributor Jim Mueller usually considers himself a value investor, but won't turn down growth, either. He owns shares in Syneron Medical. The Motley Fool is investors writing for investors.
