There’s one guiding principle that describes how everyone should behave in the markets: find undervalued stocks capable of delivering attractive risk-adjusted returns. Textbook stuff, right?
But the way to get there is as polarising and passionate as a debate between Springbok and European rugby fans. It’s a bit like politics — the Right and the Left have very different views, while the middle of that spectrum is filled with moderates who tilt one way or the other (but not so far that they need to defriend people).
The core difference between value and growth investors comes down to pessimism vs optimism in the context of valuations. I regularly discuss stocks with both types of investors and I’ve noticed that they have different emotional reactions based on the multiples the stocks are trading at.
Growth investors aren’t scared off by a price/sales multiple of 10, or an earnings multiple of 50. They believe that these multiples unwind slowly over time to more normal levels. The maths tells us that a stock can deliver great returns if earnings growth is faster than the unwind in the multiple. Growth investors treat high multiples as a sign of success and a necessary evil of investing in the best companies in the world.
The pain trade for growth investors is a scenario where expectations for the stock exceed reality. The multiples (and share prices) can easily drop 30% without the underlying earnings of the company changing trajectory. Growth investing requires a long-term view and a willingness to buy the dip rather than run away from it.
The mitigating factor is that most benchmark indices are filled with these stocks, so your portfolio drops and rises with the market instead of against it. Investors tend to find this more palatable, which is why growth funds get most of the media attention.
In stark contrast, value investors balk at the thought of paying high multiples for a business, no matter how good it is. They argue that the good stuff is already priced in, leaving no margin of safety for forecasting risk, or for something to go wrong. Instead, they seek out companies with reasonable prospects that trade at low multiples.
The hapless Stellantis is a prime example of why the industry you choose often matters more than the specific stock
Stocks trade at low multiples for many reasons, including difficult ones such as industries in terminal decline. In such cases, value investors focus on extracting the economics before the collapse. This is the furthest thing from the buy-and-forget strategy growth investors tend to follow, though a major technology shift such as AI means all bets are off in terms of which growth stocks will emerge victorious.
To be clear, both approaches are capable of great success and spectacular failure. Value investing just tends to be less popular because the portfolio behaves differently to the broad market index, so fund managers need to find investors and capital allocators who fully understand this.
The other problem is the “nobody gets fired for hiring IBM” issue: people have sympathy for you when you lose money on Microsoft, but not when you bought a company that is already unloved. Such as carmaker Stellantis, for example.
The hapless Stellantis is a prime example of why the industry you choose often matters more than the specific stock. A lot of sensible arguments could’ve been made for how cheaply Stellantis was trading, especially with a decent mix of brands and a market-leading position in regions such as Latin America. With new management in place, the company was making all the right noises (literally, of the V8 variety) to appeal once more to US buyers. But alas, with even the strongest European names failing to compete against Chinese names, there’s little hope for Stellantis. The stock has already lost 37% year-to-date after another terrible update.
Before growth investors feel too smug, class captain Microsoft is down 15% year-to-date. The difference is that Microsoft has very little chance of going bankrupt, whereas Stellantis is facing a genuine existential crisis. Then again, based on what is happening to the software-as-a-service names such as Adobe and SAP, is any company truly safe any more?
I try to view each stock based on its merits. I bought Netflix in the past week on a price/sales multiple of eight, which I think is good value for that stock. Last year, I bought Accelerate Property Fund at a dirt-cheap price/book of about 0.3 — a great trade in the end.
A pure growth investor would never touch Accelerate Property Fund, while value investors won’t buy anything at a sales multiple of eight. I choose to be more flexible than that.
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