Wall
Street Wisdom... Value Stocks vs. Growth Stocks
One would think that there would be a
pretty clear distinction between Value Stocks and Growth Stocks. But an hour or
less research, and some non Wall Street analysis, will muddy the waters significantly.
In the back of our minds, most investors think of Value Stocks as more
conservative investments than Growth Stocks, mostly larger, proven, and
profitable companies that are quite a bit safer than their Growth Stock
brethren. Value stocks, you will determine, are those that:
Tend to trade at a lower price relative to
their fundamentals.
Are undervalued and have a good
expectation of price appreciation.
The marketplace perceives to be
undervalued based on criteria such P/E, price-to-book
ratio, dividend yield, etc.
Have been out of favor and are relatively
cheap compared to the value of their
assets.
Trade at a P/E ratio lower than the market
average P/E ratio as a result of
falling prices rather than improving fundamentals.
Surprisingly, the distinguishing feature
of Value Stocks is price. How does the price of the stock relate to its
fundamentals, and if it is truly under-valued, how good are the chances for the
price to go up? The definitions mention dividends, various financial statement
ratios, and market sentiment. The problem is that there are no real benchmarks
or specifics to cuddle up to for selection decision-making purposes. What Wall
Street labels as a Value Stock is, in reality, a stock that, at a certain point
in time, is selling at a bargain price... a very temporary thing. Once the
stock goes up in price, the Value Stock label disappears.
Growth Stocks, on the other hand, are most
often thought of as flashy startups, high tech innovators, and generally more
speculative entities that should be dealt with carefully. These are the bread
and butter of both Growth and Index Funds and are the kind that the media
covers most extensively. The most popular definitions describe Growth Stocks as
those of companies that:
Are growing earnings and/or revenue faster
than their industry or the overall
market.
Pay little or no dividend, preferring to
use their income to finance expansion.
Are young, with little or no earnings
history, and which are valued on the basis
of anticipated future earnings.
Have high price-earnings ratios.
Are currently growing earnings with
potential to continue growing earnings 15%
to 30% annually for the next one to three years.
Equally surprising, to me anyway, is
that price is only mentioned as a part of the high P/E ratio expectation that
seems consistent with the Growth Stock identity. This is because price is a
tertiary consideration in this inherently speculative area, and not nearly as
relevant as those quarterly analyst projections that fuel the hysteria... in
both directions.
I don't disagree with the need for
distinctions such as this, but I have a problem with the lack of consistency in
who does the labeling, how unbiased it can possibly be, and then this one big
problem: almost any stock out there can be seen as one or the other, even at
the same time, by almost anyone who owns a calculator and who thinks they have
the ability to predict the future. Are the real estate, home building, and financial
Growth Stocks of the past three years now Value Stocks, and which of the
current Value Stocks will achieve Growth Stock prominence in 2008 or 2009? Similarly problematic is the perception that
a Value Stock must be safe and full of quality and the assumption that a Mutual
Fund full of Growth Stocks just has to grow in... value!
Its time to refine these definitions a
scooch, if for no other reason than to recognize that both are purposely
flexible concepts that attempt to compare current equity prices either with
past accomplishments or with future potential. Two things about publicly traded
companies that most investors and speculators would probably agree upon are
these: (1) High P/E, unprofitable, non-dividend paying, young companies are less
likely to be around in their present form 10 years from now than profitable,
dividend paying, low P/E, established companies; and (2) That the current
Market Price of a security is as much or more a function of supply and demand,
current events and their media spin, and world politics than it is a function
of the company's financial statements. BUT, spending more time inside a
company's financial statements certainly helps in identifying: stability,
consistency, general quality, and long-term economic viability.
In other words, what I am looking for is a
selection universe of fundamentally valuable companies that can be expected to
remain that way for a significant period of time, not just a bunch of random
symbols that someone believes are at garage sale prices. With a stable,
fundamental-value or quality universe to select from, we can use Market Price
to determine both: when a stock is available for purchase at a bargain price,
and when each of our individual holdings has grown enough for us to realize a
reasonable profit.
S & P Corporation publishes a
standardized earnings and dividends ranking system which separates stocks with
average and better fundamental qualities from those with lesser economic
strength and viability. It is
particularly useful because it excludes market analysis and projections of the
future, thus eliminating any form of hype whatever. It sticks with pure
fundamentals, financial report numbers, and ratios... market price is not an
issue. As with all marketable securities, every member of this select group of
approximately 450 higher fundamental quality companies will vary in Market
Price in either direction dependent on all of the usual market factors... but
their basic quality remains constant, regardless. I think of this group of
especially successful companies as Investment Grade Value Stocks, and I look to
them to produce above average growth in Working Capital annually and in Market
Value cyclically. Experienced investors know better than to relate Market Price
with the soundness of a company's financial statements... particularly during
stock market corrections.
Four new sets of statistics are being
developed for the FREE and exclusive use of true Value Investors, and they
should be available on the web early in 2008:
The Investment Grade Value Stock Index
(IGVSI), which tracks the Market Value
of the stocks described above.
Issue Breadth Statistics, of the
approximately 450 stocks in the IGVSI, track
the daily number of advancing and declining issues.
New High and New Low Statistics help to
pinpoint cyclical developments within
the Equity Universe.
A
monitor of the number of "bargain stocks" within the IGVSI helps to
confirm uninvested smart cash levels in equity portfolios.
Note:
The 2nd Edition of "Brainwashing" is here!
Steve
Selengut
800-245-0494
http://www.sancoservices.com
http://www.investmentmanagementbooks.com
Professional
Portfolio Management since 1979
Author
of: "The Brainwashing of the American Investor: The Book that Wall Street
Does Not Want YOU to Read", and "A Millionaire's Secret Investment
Strategy"