Growth Stocks or Value Stocks... What Will Make You More Money in this Bull Market?

Nov 28, 2019

Rahul Shah, Editor, Profit Hunter

I received an interesting WhatsApp message the other day.

  • Markets never top because the smart guys are selling. Markets top when no more fools are eager to buy further.

Well, as far as stock market in India is concerned, neither the smart guys are selling nor fools are done with their buying yet.

And which is why you are seeing this tremendous optimism in the market. As of writing this, Sensex had breached its previous all-time highs. It seems in no mood to slow down any time soon.

If you're thinking about how exactly to cash in on this rally, there are two major options before you.

You can either invest in growth stocks or you can take an exposure to value stocks.

One way out of this confusion is to look at the historical performance of these two approaches. Luckily for us, a recent article in one of the leading business dailies has done just that.

And the choice is pretty clear.

It has argued that over the past 19 years, the MSCI India value index has done better. On a rolling five-year basis, it has outperformed its growth counterpart by 200 basis points. It has returned an average of 14.9% per annum vs 12.9% CAGR for the growth index.

However, this doesn't mean that growth lags value all the time. The article further argues that when a bull market takes wing and establishes itself, growth stocks overtake their value counterparts.

And we seem to be exactly in such a kind of market. Therefore, it may not be a bad idea to invest in growth stocks.

Having said that, value style investing tends to contain losses better than growth in big bear markets. Therefore, if there is a strong correction in the market going forward, you would want to be in value stocks.

It is evident the choice is not as straightforward as it seems. Both growth and value have their pluses and minuses. You need to make an eerily accurate prediction of the future to zero in on one of these styles.

One way out would of course be to take exposure to both value as well as growth stocks and then keep changing the allocation based on relative underperformance and outperformance.

Another option would be to ignore this classification completely and implement something much simpler.

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And this is exactly what I recommend to my subscribers.

You know, I have come to believe that classifying stocks based on value and growth has very little logic to it. It is an arbitrary classification that you don't need at all in your quest to earning market beating returns.

In fact, I would like to go with Warren Buffett on this topic. Here's what he once said about growth and value stocks.

  • Most analysts feel they must choose between two approaches customarily thought to be in opposition: "value" and "growth." Indeed, many investment professionals see any mixing of the two terms as a form of intellectual cross-dressing.

    We view that as fuzzy thinking (in which, it must be confessed, I myself engaged some years ago). In our opinion, the two approaches are joined at the hip: Growth is always a component in the calculation of value, constituting a variable whose importance can range from negligible to enormous and whose impact can be negative as well as positive.

I'd rather go with Warren Buffett's definition.

Your way ahead is now simple. You should no longer segregate stocks based on growth and value.

Instead, you should consider growth as a component of value always and not a separate entity. Try to find out whether it has a positive or a negative impact on the intrinsic value of the company.

I have a simple thumb rule to verify this. If a company manages to fund all its growth internally and still has some cash left to payout as dividends, its growth is having a positive impact on value.

This company is becoming more valuable year after year and should be on your radar for making an investment.

However, if a company should keep borrowing to fund its growth and therefore has no cash left, in such companies, growth is having a negative impact on value. You should stay away from such companies and not buy into them, no matter how attractive the valuations.

This is precisely my endeavor in Double Income.

I only recommend companies that are cash generating machines and where there's plenty of cash still left after accounting for the growth needs. All the four stocks I have recommended so far pass this test with flying colors.

It is the best of both worlds if you ask me. The company becomes more valuable year after year and you get paid while you are invested in the stock by way of dividends.

So rather than segregating based on growth and value, we'd rather have both. A growing earning stream coupled with a valuable dividend component.

Warm regards,

Rahul Shah
Rahul Shah
Editor, Profit Hunter
Equitymaster Agora Research Private Limited (Research Analyst)

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Nov 28, 2019

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