Which stocks to own, growth or value?

Mar 14, 2013

In this issue:
» Why are home prices not falling?
» After gold, RBI now changes view on current account deficit
» Infosys hints at returning cash to shareholders
» What's on Jim Rogers' mind these days
» ...and more

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'Value investors back in fashion', screams the headline of a leading international business daily. It has been five terrible years for value investors, the paper writes further. And then it further supports its statement by pointing out how value based mutual funds have beaten the growth focused rivals for the first time in five years.

Thus, with the data in its favour, we see nothing wrong with what the newspaper has written. What we are concerned about though is whether the data itself has its heart in the right place. The agency compiling the data has indeed sorted out funds into value and growth. But are the assumptions that have gone into this sorting totally foolproof?

In fact, is there really such thing as value and growth? Well, to us, this compartmentalisation of stocks between growth and value appears a bit silly. Of course, value investors can argue that their philosophy of buying stocks with low P/E or low price to book value is superior to the growth option. This argument though falls flat on its face. For there are examples galore where cheap stocks have remained cheap forever. Thus, value investors can hardly guarantee that value style of investing always helps them buy stocks trading lower than their intrinsic values.

Similarly, buying stocks with high PE and high price to book value does not automatically mean that one is engaging in growth investing. Simply because a stock bought at high valuation can still prove to be a very good long term bet if earnings keep growing at a strong pace for many years into the future. In other words, there is a chance that one is buying a growth stock which ultimately turns into a value investment because of the high growth rate and ultimately, high market cap in the future.

Thus, we believe investors would do themselves a world of good if they remove growth and value biases from their minds. As Warren Buffett says, growth is always a component of value and hence, cannot be divorced from value investment. Where stocks could differ though is the influence the growth has on the intrinsic value of the stock. There are stocks where growth has a significant impact on value and then there are cases where growth has a negligible impact. In fact, growth is also known to destroy value in a lot of cases. What we mean is growth benefits investors only if the business can generate attractive return on capital. If the business has poor returns, growth will only hurt value.

Thus, the next time you analyse stocks, forget whether you are engaging in value or growth investing. Concentrate all your efforts on calculating the intrinsic value of the stock and then ensure that you buy it at a small discount. It should not matter whether the stock under consideration is high P/E or low P/E stock.

Do you think it makes sense to classify stocks as growth and value stocks? comments or post them on our Facebook page / Google+ page

 Chart of the day
On an aggregate basis, India does not do all that bad. It consistently figures on the list of countries with the highest production of a lot of important goods. But bring its huge population into the picture, and things change for the worse. Quite worse we should say. Today's chart of the day is another example of this. When it comes to spending on food, India seems to spend the lowest on a per capita basis. This is not only in comparison to the US but also its BRIC peers as the chart highlights. We don't know how much of this could be attributed to the Government's food storage and distribution policy and also to the prices of food items in various countries. But one look at the poor around us and we come to the sorry conclusion that we indeed have a long way to go when it comes to poverty alleviation and food security for all.

Data source: The Economist

Here's a solid proof of slowdown in the Indian economy. In February, car sales plunged sharply by 25.7% year-on-year (YoY). It indicates that consumers are expecting bad times to go on or maybe even get worse. As such, they are deferring the purchase of a high cost item now. Consequently, auto companies are offering discounts and freebies to lure buyers. This is plain economics.

But why does the same economic logic not apply to another high cost asset called real estate. There is clear evidence that real estate sales have slowed down. For instance, home loans comprised 12.9% of the total loans given by banks in March 2006. Of late, the proportion has fallen down to about 9.3%. And mind you, this is despite the fact that home prices have shot up astronomically during this period. What is happening really? Why are home prices not falling?

An article in Firstpost presents an interesting perspective. One reason is that the housing market is dominated by investors and speculators. Most of these buyers find real estate a lucrative place to park their black money. And this keeps home prices high. The other factor is the supply of land. One may wonder how there can be a supply scarcity in a vast country like India. But the sad fact is that land in India is under the clutches of politicians. And these are the people to be blamed for the exorbitant home prices.

The Reserve Bank of India (RBI), it seems, is rethinking about its stance on various aspects. Yesterday we told you about how the central bank has changed its view on gold. The RBI is no longer as worried about the impact of gold buying on current account deficit (CAD). But there is more to it. Another problem that the RBI had flagged earlier was the impact of lower interest rates on CAD. However, as reported in DNA, it no longer holds on to that view. That is the CAD problem is no longer an impediment to interest rate cuts. RBI has also offered several reasons for its view. One is that during a slow growth period, as is the case now, a rate cut is unlikely to translate into import demand.

Secondly, lower interest rates will also improve India's export competitiveness. Thirdly, lower commodity prices, especially crude oil, have eased the pressure on CAD to some extent. Lastly, in emerging economies like India, import demand is less a function of lower interest rate than of increased income. Thus, the RBI is no longer as rigid as earlier on its rate cut stance. But we would not want to hazard a guess on whether and by how much will the RBI ease interest rates. All we could conclude is that the RBI is taking the government's fiscal commitments seriously enough.

When it comes to what is happening in the investing world, Jim Rogers views always attract a lot of attention. And in his latest interview, he has given quite an interesting take on the state of affairs globally especially in the US. For starters, on the origins of the housing bubble and the financial crisis, Jim Rogers is appalled at how people chose to believe in the most absurd things. Indeed, he opines that if something's too good to be true then it's probably not true. So when Americans having no jobs and no immediate money were in a position to buy 5 or 6 houses, you would have thought that it was very easy to smell a rat. But that did not happen and what the world was witness to was the worst financial crisis since the Great Depression.

Not just that, the way that governments have chosen to deal with the problem is also something that baffles Mr Rogers. He opines that rather than propping up banks and companies with stimulus measures, they should be instead allowed to go bankrupt. This will pave the way for new capital and new ideas for growth. A process that can be termed as creative destruction. These are important nuggets of wisdom from Mr Rogers and a view that we most certainly concur with.

The bellwether of the Indian IT industry, Infosys has amassed a huge cash hoard of US$ 4 bn or Rs 220 bn. This is enough to buy 16 Boeing 787 Dreamliners. But since the company isn't buying any planes, it has finally decided to spend its cash in one way or another. Either this cash will be given back to investors or it will be spent on acquisitions. Infosys' previous acquisition was the Rs 350 m purchase of Swiss enterprise software consultancy Lodestone last year. It has now set itself a time-line of 12-15 months for making a new purchase. And if there is no major deal in this period, investors could very well see cash being returnd to their pockets.

This may come either in the form of a buyback or dividend. Plus, in light of increased competition and falling market share, the company has become more flexible in client engagement and is taking more risks. Well, for years the company has been too conservative and overly cautious. However, we just hope that this new found vigour doesn't force the company to make a hasty acquisition or sacrifice margins.

Meanwhile, indices in the Indian stock markets moved into the positive territory after spending most of the morning session in the red. The Sensex was trading higher by 145 points at the time of writing. Maximum buying interest was seen in realty and banking stocks. While Asian stock markets closed mixed today, Europe is trading in the positive currently.

 Today's investing mantra
"If an investor had bought at the absolute lows, it would have been more a matter of luck than anything else." - Philip Fisher

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3 Responses to "Which stocks to own, growth or value?"


Aug 1, 2014

When EM research team itself is not able to give Intrinsic value ,how do ordinary investor do it.
If EM gives intrinsic value, it will be a great boon gor ordinary investors


Borkar Madhukar

Mar 16, 2013

Infy. management is considered to be more ethical. I recollect, long back may be some 30 years, when GLAXO found itself in similar situation, piled up cash, and did not see any positive investment opportunity, returned that money to the shareholders by way of special dividend to whom that belonged (if not followed conservative dividend distribution that cash would not have been there in the trove). I still remeber the letter/notice/circular whatever u want to call it said "we do not see any good opportunity to invest this money in the near future" and money was given back to the shareholders. Follow this example as Charity Begins at Home. - Borkar


manoj kumar agrwal

Mar 15, 2013

5 Minute WrapUp directly ko aap hamari mail per daal rahe ho ple coll me

Equitymaster requests your view! Post a comment on "Which stocks to own, growth or value?". Click here!