Buying growth versus buying value in the markets - Motilal Oswal
Buying growth versus buying value in the markets - Motilal Oswal

Buying growth versus buying value in the markets

From an investment perspective, there are broadly two approaches to buying stocks. There is the Growth approach versus the Value approach. Simply put, the growth approach chases growth while the value approach chases value. Indian investors and fund managers have typically veered between these two forms of investing. Before getting into the nuances of what these investing styles mean, let us look at a quick chart. The chart below depicts how the NSE Growth index has performed versus the NSE Value index. For easier comparison, both the indices have been factored to a base of 100. As the comparative chart depicts, there not much choose from over the last one year. Of course, the value index has marginally outperformed the Growth index over the last one year. That could be more because the growth index contains a generous sprinkling of pharma and FMCG stocks, which despite above average growth have not been the darling of the bourses. On the other hand, there are the value stocks that are dominated by banks and oil companies that have performed exceedingly well in the last one year

Deciphering the idea of growth stocks
There is no hard fast definition of a growth stock. Growth companies are those that are able to show consistent growth irrespective of the macroeconomic conditions. Take the case of pharma and FMCG companies in. Growth in both these sectors has been largely independent of the overall economic cycles. While pharma is not growing at the peak rates seen earlier, it is still sustaining growth raters that are substantially higher than other sectors. More importantly, both these sectors are not exactly cyclical in nature. That positions it quite unlike sectors like metals and capital goods that are too cyclical in nature. One of the ways to identify a Growth stock is the P/E ratio. If we were to go back to our example, both the FMCG sector and the pharma sector enjoy a very high P/E ratio as their business model combines the benefits of high growth and high return on equity (ROE). Investment in growth stocks is based on the premise that even at high P/E ratios these stocks are attractive as the growth and ROE will justify higher valuations. That is why you see sectors like Pharma and FMCG consistently quoting at P/E ratios in excess of 30-40 times earnings.
Deciphering the idea of value stocks
Value stocks, on the other hand, represent stocks that are out of favour and are available at bargain prices. You can have a value stock that is quoting at single-digit P/E ratios or which is quoting at a discount to the replacement value or stocks that are priced much lower than peers in the industry. Classic examples could be PSU banks that are quoting at single digit valuations, Oil marketing companies (OMCs) a few years back just before free pricing was introduced and metal companies before the government adopted a more pro-industry policy. In all these cases, there was a clear trigger for the discovery of value. That is the key. It is not just enough to identify a value stock but it is also essential to identify the tipping point that could lead to a turnaround in these stocks. The closer you buy to the tipping point, the better your ROI.
Practically speaking; growth versus value investing
Practically speaking, these are not exactly discrete choices. Most fund managers combine both these styles of investing. Fund managers purchase value stocks as they need to earn big returns on a few stocks to ensure that alpha is generated in the portfolio. Growth stocks are the safe bets in any portfolio. Most growth stocks are companies with a sterling track record of growth in top-line and bottom-line. In these cases, the probability of going wrong is quite low. The similarity is that in both these styles, the focus will predominantly be on quality companies with sound fundamentals and strong future prospects. While there is no empirical evidence, value stocks have tended to perform better over longer periods of time.
Basic cautions in the growth versus value argument
In the debate over growth versus value, one should not miss out on some core points..

While buying growth stocks one needs to be cautious of disruptive technologies. Many businesses like electronic hardware, hotels and automobiles are all being impacted by disruptive technologies. If you are buying these stocks from a growth investing perspective, you need to be cautious of how disruptive technologies could impact future growth and ROE of your companies.

If you are focused on value stocks, then you need to be cautious of the Value Trap. Many companies with low P/Es and low P/BVs tend to sustain at low valuations for long due to larger fundamental problems that may not be apparent. Investors, therefore, need to be doubly careful while buying value stocks at bargain prices.

Timing matters a lot! Here we are referring to the market conditions when you are taking the investment decisions. Typically, when markets are quoting at the lower end of the valuation range, value investing will tend to work better. That is because the downside risks of these value stocks become almost negligible.

Lastly, growth stocks tend to outperform when the macroeconomic cycle and corporate performance are maintaining a steady positive clip. Then markets attach more importance to buying growth rather than buying value.

The value and growth approach are more often than not, complementary rather than being competitive. If implemented at the right time with the right checks and balances, both these approaches work to perfection!

Ready to invest with us?

Share your Name and Mobile Number with us and get started

  • +91|