Value or growth? Growth or value? In my mind, the ageless debate about investing temperaments isn't even really a debate. So many investors take on unnecessary risk chasing overvalued stocks in the hope that one will be the next Microsoft
The one-string fiddle
I know quite a few investors who actually bought Microsoft or Intel
But get-rich-quick stories like that prey upon the optimism (or greed) of investors hoping to strike it rich in the market. They obsessively search for the "next big thing." The next big thing often spells disaster for the average investor.
The story goes like this: You only need one of your stocks to take off like Microsoft. It doesn't matter what happens to the others. To which I say: Yeah, right! What happens in the likely event that you don't have the next Microsoft in your portfolio?
I call this the one-string investment portfolio because your returns are predicated on the success of a single string. If the next big thing crashes and burns, your portfolio seriously underperforms. Do you really want to put your cash at risk by investing in highly overvalued potential Microsofts? The premise that it doesn't matter what happens to 90% of your investments as long as 10% go to the moon just seems like fuzzy math to me.
The typical one-string investor chases -- and a chase it often becomes -- high-growth glamour stocks, without a thought of value. Those stocks have charts reminiscent of Icarus' flight path. Remember Icarus? He thought he could fly like a bird, but accidentally flew too close to the sun and came crashing to the ground. The market is littered with Icarus-type stocks. KrispyKreme Doughnuts, selling for a shade less than $50 in August 2003, now fetches $8.35.
At our Motley Fool Inside Value newsletter advisory service, we know that you can still produce outstanding returns without taking on the unnecessary risk that comes with "one-string" investing. If you buy Taser today, you are paying $45 for every $1 of earnings. Turning the P/E on its head -- that is, looking at the E/P ratio -- your earnings yield is a measly 2.22%; heck, even an ING Direct savings account will pay you 2.35%.
Yes, I know about the high-growth predictions for Taser. Put bluntly: I'm not willing to bet on those predictions. Another glamour pin-up is Sirius Satellite Radio, which carries with it the followings of Martha Stewart and Howard Stern. Sirius has a market cap of $7.7 billion, sales of $100 million, and an expected earnings growth rate of 35% over the next five years. The company currently has negative earnings and free cash flow, and assuming 35% growth, it will not break even before 2008 or 2009. Perhaps more disturbing is that as Sirius grows, it is destroying shareholder value (book value per share decreased from $1.20 to $0.77 in the past year). All I can say is: There better be a pot of gold at the end of that particular rainbow! Sirius is under $6 now -- which doesn't make it cheap. But what on earth were investors doing paying $60 for Sirius in early 2000?
The 12-string guitar
I know that a 12-string guitar can make beautiful music, and even with a broken string (or two), a musician can still play. The one-string fiddle? Horrible to listen to, and when it breaks, there's no music at all! So let me introduce you to some value strings that you could have played, and I don't need to go back to the mid-'90s or look under rocks to find them:
String 1: McDonald's: $12 in March 2003, now $29; up 141%.
String 2: Bank of America
(NYSE:BAC): $19* in November 2000, now $46; up 142%.
String 3: Alderwoods: $4 in April 2003, now $14; up 250%.
String 4: Providian Financial: $2 in November 2001, now $17; up 750%.
String 5: ConocoPhillips
(NYSE:COP): $27* in November 2003, now $55; up 103%.
String 6: Kinder Morgan: $30 in October 2002, now $80; up 167%.
String 7: FairfaxFinancial
(NYSE:FFH): $47 in March 2003, now $159; up 238%.
String 8: School Specialty
(NASDAQ:SCHS): $17 in April 2003, now $46; up 170%.
String 9: Cardinal Health
(NYSE:CAH): C$36 in October 2004, now C$58; up 61%.
String 10: AutoZone: $61 in March 2003, now $92; up 51%.
String 11: First American: $25 in July 2004, now $40; up 67%.
String 12: MCI: $12.50 in June 2004, now $25; up 100%.
These are just a few of the stocks that our Inside Value team members identified (Alderwoods is a Motley Fool Hidden Gems recommendation). The real beauty here is that you didn't have to come close to the bottom (or have bought everything in the spring of 2003) to make a ton of money. Even better, you can learn to do it for yourself. I invite you to take a free trial of Inside Value to find out how.
More than a single instrument
Study after study proves that value investing outperforms growth investing over time and that the high risk involved in high-multiple growth stocks leads to, well, high risk -- without the high reward. Ibbotson Associates, the king of market data and analysis, found that from 1926 through 2002, growth investing returned a compound growth of 9.2%, while the S&P 500 returned 10.4%. Value investing trumped both, returning 12.4%!
Looking for more recent comparisons? In 1994, Lakonishok, Shleifer, and Vishny (collectively, LSV) found that value kicked growth's butt by an outstanding 10% -- 19.8% to 9.3% -- from 1968 to 1994. More recently, the Brandes Institute updated LSV's study to include data through 2003; it came up with the same conclusions. Moreover, Brandes found that the average annualized five-year return was 19% for value and 9% for growth.
So, the question remains: Do you want to play a one-string fiddle or a 12-string guitar? Do you want the proven outperformance of value? Do you want to invest or speculate? The choice is yours, but even if you decide that one-string-fiddle investing is your style, I invite you to a free, no obligation trial of Inside Value. Click here for more information.
This article was originally published on Jan. 18, 2005. It has been updated.
Philip Durell is the analyst for the Inside Value newsletter. He owns shares in Alderwoods, and his wife owns shares in First American. First American is a current Motley Fool Inside Value recommendation. Taser is a Motley Fool Rule Breakers recommendation. Krispy Kreme is a Motley Fool Stock Advisor recommendation. The Motley Foolhas a disclosure policy .