Warren Buffett famously said that the distinction between value investing and growth investing is not real, because value investors want growth and growth investors do not want to overpay. Critics echo this point, stating that the distinction is false and was created by academics in the early 1960s and has subsequently been taken up by the investment consulting community. Nevertheless, more than 80% of our CFA Institute Financial NewsBrief readers think there is a difference between value investing and growth investing, with the most popular distinction being that value investors focus on fundamentals and growth investors on momentum.
What Is the Primary Difference between Value and Growth Investment Philosophies?
Equal numbers of this group of respondents say there is a difference in preferred time horizons and that value investors focus on mean reversion whereas their growth peers focus on idiosyncratic risk. A smaller minority believe that differences in required rates of return divide the two investment styles. Most surprising is that only one in six respondents agree with Buffett's view that there is not much difference at all.
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16 Comments
Annual return from holding a stock has 3 components in general: 1) change in valuation/multiple 2) change in fundamental (denominator of valuation/multiple) 3) dividend yield. We could argue that value investors focus more on the first component, while growth investors focus on the second component. However successful investors must take into account both components in the long-term!
Hello Michal,
Thank you for sharing your thoughts on this perennial topic. I think that your framework is a smart one and also think your mapping of value and growth to that mental model is sound.
With smiles!
Jason
Very interesting, thanks for sharing Jason! What do you think, do you differentiate investments you make into a value or growth category?
I only invest my own money but I think, for me, it boils down to probability of a set of outcomes (X1, X2...Xn) multiplied by the outcomes (E(r1), E(r2)...E(rn)). I'm making a mental calculation and not actually doing the math but it's how I think it about it generally. I don't distinguish value vs. growth because I suppose I would find it limiting and I'm not sure what value I would get from it anyway so I'm curious how others find value in classifying investments by type.
Hello Rob!
Thanks for taking the time to engage!
I think for me the question has a multi-part, layered answer.
First, I personally do not differentiate between value and growth. I spend my time doing the things in which I think I have skill. Namely, the evaluation of business models, their prospects, and their management; and then in modeling the future performance of the business. Then I decide where in the cash flow stream (i.e. in the income statement) I want to take an interest. Sometimes that means I buy the debt, sometimes the preferred, sometimes the equity, sometimes a combination of all three. There is a name for a company with flat growth prospects: fixed income. So growth is always a part of a valuation. So my own view is that Buffett is correct in his assessment.
That said, I think academics invented a distinction with their famous book to price studies, that was without much meaning. Then the investment company and consulting industry along with investment company evaluators (e.g. Morningstar and Lipper), have forced the creation of these distinct philosophies. So, in practice there is a distinction...nowadays, where once there was not. That leads me to my second point: I think all of the distinctions in the question are real, but I would say the primary distinction is a difference in time horizon and risk. I do not think you can decouple time horizon and risk. Let me explain. Growth investors tend to take more risk than value investors. In order to justify these risks they need to earn higher rates of return, which in turn compresses their time horizons. After all, they don't want to double their money over 100 years, but over the next two years.
By the way, I think you are super smart to be aware of your mental models, one of which you describe above. To know thyself is the key to great investment success.
Big smiles!
Jason
Your response was very helpful, thank you Jason! I would be remiss not to mention how much your book has helped me with the " the evaluation of business models, their prospects, and their management; and then in modeling the future performance of the business." I learned how to model (I speak specifically about the mechanics of a DCF model) well before I learned how to make a determination about 1) what I thought to be the most relevant factors and 2) how to understand and clarify what most likely would unfold in the future for the most relevant factors.
Hi Rob,
What kind words to read this morning - thanks!
With smiles,
Jason
What the value stocks distinguishes from the growth stocks, is predominantly the dividend that is provided by value stocks. Further, the value stocks are mostly the blue chip stocks whereas the growth stocks are undervalued companies.
Hello Farhad,
Thank you for your comments. The distinction you outline is in close alignment with the typical finance academic. Thanks for ensuring it is a part of the conversation.
With smiles,
Jason
Hello Jason
In your response to Rob Wilson you mentioned "Growth investors tend to take more risk than value investors.".
I was hoping you could clarify further.
Hello Nabeel,
Thank you for your asking for clarification. What I meant was that just as there are growth investors there are growth companies. Growth companies are those that are growing some portion of their income statement (e.g. revenues, EBIT, EBITDA, or earnings) faster than most other companies. Often this growth is in new business lines where returns are more uncertain than in more established businesses. Think: Apple selling iPads 4 years ago; or Vonage selling Internet based calling 10 years ago. High growth, but high risk, too. So to invest in a growth company, and that is the kind of company most growth investors look to invest in, menas taking on greater risk. Does that make sense?
With smiles,
Jason