Growth vs Value Investing: Why Your Portfolio Needs Both
Let’s use two famous investors as proxy for our comparison. First, Warren Buffet (value) who is famously a self-made investing billionaire. Second, Cathie Wood (growth) who is famous for identifying disruptive growth technologies and the companies that benefit from them.
Value investors firmly plant their flags in the Buffet camp. True value investing is buying companies that are out of favor with the market. They often carry an operational or financial distress or both. Value investors are buying these companies cheap, but for a reason. The hope is that there will be a turnaround in the company’s fortunes, and their stock prices will increase at a better-than-market rate.
This is a COMMON misconception with the value category. Many people think value stocks are for retirement (because they often pay dividends) and growth stocks are for pre-retirement. The “I want my money to grow, so I buy growth stocks” notion is incorrect. What are two good recent value stock examples? Carnival Cruise Lines and Hertz Rent-a-car. If you thought either of those stocks had fallen too far given COVID measures, you would have purchased them at their perceived discounted valuation. If you were right, and they recovered, you would have enjoyed a better-than-market return.
Growth investors tend to look to Cathie Wood. She invests heavily in disruptive companies. Many of these companies have yet to turn a profit, have a massive addressable market for their product, and burn cash like crazy. The ones that do show profits often reinvest them for future growth. What another way to commonly sniff out a growth company? Huge valuations. What’s better? We’re not here to answer that. If you tracked growth, you would’ve beaten value over the last 13 years. Impressive. Prior to that, value was superior to growth the previous 80 years! Picking one over the other assumes we know what the future will bring. We simply don’t. Why not own both?
Source: Dimensional Fund Advisors
A well-diversified portfolio will allow you to capture upside whether that is value or growth. More importantly, your portfolio won’t suffer as much if the market favors one or the other. We talk about this in client meetings all the time, you don’t have to have all of your money in the best performing area of the market to succeed. If you own all areas (and you believe that no one can accurately predict the future), you will always own some of the best-performing areas of the market. This also allows us to systematically, and unemotionally, rebalance your portfolio by selling the winners and buying the losers, to bring your portfolio back to its pre-determined allocation. Isn’t that what we’re all trying to do in the first place?! Buy low, sell high. We like to say, sell high, buy low.
You will also see us tilt portfolios one way or another but never vacate growth or value completely. When we’re designing and maintaining portfolios catered to your individual needs, we’re not simply balancing growth vs value. We are looking at the impact of bonds, international stock, emerging markets, etc. Said simply, over the long-term, you’ll likely achieve the same or slightly better rate of return, by taking slightly lower risk, when you own a properly diversified portfolio.
Cathie Wood may be out of favor at the moment, but recall very recent headlines about Warren Buffet’s missteps. “For A Smart Investor, Warren Buffett Sure Slipped Up When It Came To Airlines” Forbes, May 2020. Source: Forbes: For A Smart Investor, Warren Buffett Sure Slipped Up When It Came To Airlines
Even the world’s greatest investor will make mistakes. The market has a way of humbling even the best. We use “humbling” in the very loosest sense. I doubt Warren Buffet really cares what Forbes says about his trades. If he does, he’d wipe away tears with all the money he’s made in his lifetime. Cathie Wood has been getting a lot of negative attention lately, again probably wiping tears with the money she’s made. Both are very public figures in the investing world with two different approaches to success. There will be times when one is the GOAT and one is the goat. Both have worn both titles.
Breaking down each approach, academics have identified risk premiums or factors that make up securities behavior. Risk premiums are based on an expected return above the risk-free rate. The risk-free rate is generally a US Government T-Bill. I invest in stock, I expect a return above the risk-free rate to compensate for the risk I’m taking. Risk/Reward.
Academics have studied Warren Buffett’s approach to investing, which in its simplest terms is “buy good companies cheap and hold them forever”. Buying good companies cheap is implying a value purchase. Warren Buffett’s most successful investments typically had several things in common. He bought them when they were out of favor with the market. An example was when he bought banks in 2009 while the market was questioning whether they would be able to stay in business after the financial crisis. Reading this, we have the benefit of hindsight but very few investors were buying banks during the Great Recession. The banking industry fit the bill of a value investment at that time, which is a company under financial or operational distress. Identifying and buying value names here, Warren Buffett knew he was taking on more risk and was rewarded for it. What I’m trying to convey here is true value companies carry more investment risk because we are banking (pun intended) on a turnaround.
To be fair, Cathie Wood’s approach is exponential growth or disruptive growth. Growth companies traditionally reinvest their profits for a payoff down the line, if ever. Starbucks reinvested profits into opening new stores worldwide to increase sales volume in the 90s and early aughts. It wasn’t until 2010 that Starbucks initiated its dividend. Source: Starbucks Announces Increase in Quarterly Cash Dividend.
Cathie Wood has been focused on exponential growth focusing in areas such as automation, artificial intelligence, electric vehicles, and other disruptive companies. Many of these technologies are so new that the general population is years away from full adoption. There will be many failures as many of these companies will never achieve profitability.
Using recent history as an example of how this may pay off for investors, we would look at Netflix, Amazon, and Google. People questioned the quality and stability of video streaming when Netflix decided to taper off their DVD delivery service. There was also hesitancy to shop online on Amazon as security questions arose. Investors had serious doubts about Google actually generating revenue through web searches. Again, with the benefit of hindsight, all three of these companies now have a clear pathway to profitability and early investors were rewarded handsomely. Still, for every Google, there are countless Yahoo’s and Netscapes. Growth investing carries a different risk where investors are typically paying a premium to own shares, hoping the premium continues.
Value and growth bring their own risks, but together they basically make up the stock market. We tend to think of growth being technology-based, which can be true for the most part. IBM and Oracle are some of the biggest tech names but we wouldn’t define them as growth. Signature Bank is a regional bank but we don’t consider it a value stock.
Warren Buffet was successful for decades because he inherently identified an important investing factor, which was the value premium. Cathie Wood was successful because of another factor, momentum. Sometimes, both factors are in favor and sometimes one beats the other. Our job is to balance the two, to make sure that if growth runs up for the next 5 years (for example), you don’t have an outsized portion or your portfolio allocated to that sector. The same with value, whether that be an underweight or an overweight. We’re always monitoring the underlying holdings of each fund and measuring the risk factors that drive returns. At times, the name of an ETF or mutual fund doesn’t accurately articulate what its underlying investments are, and worse, fund managers can drift over time.
We believe in actively managing your financial plan more than actively managing your investments, but we still spend a significant amount of time making sure that what we’re buying in client accounts actually maintains a proper mix of stocks, sectors, and size of companies.
Disclosures
The information provided is for educational and informational purposes only and does not constitute investment advice and it should not be relied on as such. It should not be considered a solicitation to buy or an offer to sell a security. It does not take into account any investor's particular investment objectives, strategies, tax status or investment horizon. You should consult your attorney or tax advisor.
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