What is Value?

Two Types of Investment Styles

Most analysts and investment advisors subscribe to one of two types of investment styles.  The two most common styles of investment are 'growth' and 'value'.  These two investment styles are often thought of as opposing styles.  Warren Buffett once joked in his annual letter to Berkshire Hathaway Shareholders that, "many investment professionals see any mixing of the two terms as a form of intellectual cross-dressing."

A simple google search of value vs growth investing reveals the divide in the investment industry that most clients are probably unaware of.  But what is the difference between growth and value investments?  Well first I'll tell you what the conventional definitions of the two styles are, and then I'll tell you why the conventional definitions aren't all that accurate anyways, and why you should probably be ignoring them.

Growth Stocks

A growth stock is exactly what it sounds like.  It is a stock that an analyst believes will grow faster than the overall market or some subsegment of the market.  Growth stocks can be found in all sizes of businesses though they are more likely to be smaller companies because their relative small size gives them more opportunity to grow. One way that growth can happen is the expansion of the overall market, such as the growth in the market of smartphones since the first iPhone was introduced in 2007. Since that time there has been tremendous growth in the market for iPhones and Apple was a very big growth story as a company.  

Another method of achieving growth would be to take market share away from your competitors.  This has also played out in the smartphone market.  Even though Apple was the first mover and is still one of the largest sellers of smartphones, they have been supplanted by companies like Samsung as the largest sellers of phones. Samsung has been a growth story in its own right, but that growth has come not just from an expanding market for smartphones, but also from taking sales away from Apple.

Value Stocks

Value stocks on the other hand are usually more established companies that are trading below the price that analysts feel the stock is worth.  There are a variety of metrics an analyst can use to determine if the stock is undervalued, such as:

Price to Earnings (P/E) ratio – the market price of one share of the stock divided by the earnings (profit) per share of the company.

Price to Book Value (P/BV) – the market price of one share of the stock divided by the book value per share.  Book value is a measure of the value of the assets the company owns such as land, buildings, equipment, or cash.

Price to Free Cash Flow (P/FCF) – the market price of one share of the stock divided by the amount of free cashflow per share.  Free cashflow is similar to earnings but is slightly different. It measures the amount of cash a business generates which can sometimes be more useful for analysts than measuring the earnings of a company.

Dividend yield – the amount of dividends a company will pay per share annually, divided by the current market price of one share of the stock.  Dividend yield is an easy way of comparing the dividend amounts paid by different companies.

What value measure an analyst uses when deciding whether the stock is undervalued can vary widely from analyst to analyst, and many analysts use more than one metric before deciding that a stock is undervalued.  A good example of a value stock at the present moment is Bed Bath & Beyond.  This stock has bounced from it's most recent lows in August, but it is still very cheap by most of the value metrics above. Bed Bath & Beyond currently trades at a P/E ratio of 7.84, a P/BV ratio of 0.8 and a dividend yield of 5.63%, on October 11th at market close.  

Now of course there are reasons why Bed Bath and Beyond trades so cheaply.  As many people are aware, retail stores have been under pressure from e-commerce companies like Amazon for quite some time now. Bed Bath & Beyond's sales have been stagnant or even shrinking over the past few years, so there is definitely a risk that future earnings will not be as good as present earnings.  However, value stocks as a whole tend to outperform because the market tends to exaggerate the problems these stocks have and eventually they revert to the mean.

Growth and Value Aren't Mutually Exclusive

There are now hundreds of mutual fund and ETF products which are designed around these two investment styles, and in fact many advisors even build their portfolios by deliberately mixing the two styles so as to "diversify" their portfolios by style. My view on this separation of value and growth is that it is all a little silly. Growth and value aren't mutually exclusive at all.  

Charlie Munger has famously said that "All investing is Value Investing". Of course whenever you make an investment, you want to pay the minimum price possible for the investment. That's not controversial, its just logical.  The less you pay, the higher returns you're likely to get, whether you're buying a stock with lots of growth, or with little to no growth.

On the other hand, growth is not different than value either.  On the contrary, growth is an inherent component of value.  The more a company is likely to grow, the more valuable it is, and therefore the more a rational investor should be willing to pay for it.  Just because a company is growing rapidly doesn't mean the market won't occasionally undervalue it.  

Example

One example of a company with rapid growth which could still be called undervalued is Alibaba Group Holdings.  For reasons related to the trade war and other macroeconomic factors, its stock price trades far below comparable tech companies in the US, even though it is faster growing and more profitable than many of those companies.  This is a great example of how the market can undervalue growth.

Whether or not you use the terms "value investing" or "growth investing" doesn't much matter. Getting caught up in definitions like value and growth can sometimes distract investors from what's really important.  The important thing to remember in investing is that you need to be able to come up with a reasonable valuation for the company you are buying so you can ensure that you are not overpaying.  In fact, in order to truly call it investing, you should pay far less than what you think it's worth, so that you have an adequate margin of safety built in to your purchase price.  If you do this, you should get adequate returns, no matter what your style is.

- Craig White, BA, LL.B., CIM

Craig White is an Investment Advisor at Endeavour Wealth Management with Industrial Alliance Securities Inc, an award-winning office as recognized by the Carson Group. Together with his partners he provides comprehensive wealth management planning for business owners, professionals and individual families.

This information has been prepared by Craig White an Investment Advisor for Industrial Alliance Securities Inc. (iA Securities) and does not necessarily reflect the opinion of iA Securities. The information contained in this newsletter comes from sources we believe reliable, but we cannot guarantee its accuracy or reliability. The opinions expressed are based on an analysis and interpretation dating from the date of publication and are subject to change without notice. Furthermore, they do not constitute an offer or solicitation to buy or sell any of the securities mentioned. The information contained herein may not apply to all types of investors. The Investment Advisor can open accounts only in the provinces in which they are registered.