MINNEAPOLIS, MN--(Marketwired - Apr 9, 2013) - "All intelligent investing is value investing -- acquiring more than you are paying for. You must value the business in order to value the stock."
In the eyes of most stock market investors, value stocks are typically perceived as a safer bet than growth stocks. After all, the very term "value" insinuates that the stocks are selling at a price that represents a value or a bargain for the investor -- that you are buying these stocks at an advantageous price that tends to minimize the downside risk.
But in his book, Benjamin Graham and the Power of Growth Stocks, Frederick Martin of Disciplined Growth Investors makes the case that over the long term, the potential advantages of investing in growth stocks far outweigh the few benefits of value stock investing.
What's the difference between value stocks and growth stocks? Martin defines a value stock as "a mature company that is growing more slowly than the average company" and a growth stock as "a company that grows faster than the average company over the long term and earns a satisfactory return on its investors' capital."
The late Benjamin Graham, who is widely considered to be the "Father of Security Analysis" defined a growth stock as "one which has done better than average over a number of years in the past and is expected to do so in the future" in his book, The Intelligent Investor. In the 1962 edition of his book, Security Analysis, he further explained that "the term 'growth stock' is applied to one which has increased its per share earnings in the past at well above the rate for common stocks generally and is expected to continue to do so in the future."
By definition, Graham seems to make the case for growth stocks as the preferable choice for long-term investors. Yet most of the stocks Graham purchased during his career would be considered value stocks -- slow moving stocks he could buy at a discount to their fair market value and sell when their price increased. The fact is, by nature Graham was not a long-term investor, but rather a short-term trader who scoured the market for bargains that he could turn over quickly for a small profit.
Ironically, his most successful investment was a growth company, GEICO, that he bought for $27 per share and watched grow to the equivalent of $54,000 per share. That single purchase, which accounted for about a quarter of his assets at the time, ultimately yielded more profit than all his other investments combined. So while he is widely associated with value investing -- and has been dubbed the "Father of Value Investing" -- he enjoyed immense success as a long-term growth investor.
Advantages of Growth over Value
Martin has spent his career focusing exclusively on growth stocks as the managing director of Disciplined Growth Investors, a Minneapolis money management firm. In his book, he makes the case for growth stock investing, offering several important draw-backs to value investing:
- Constant trading. Value investors must spend their life researching and buying stocks at a price they believe is lower than the company's intrinsic value and selling them at a price that is equal to or higher than their intrinsic value. By contrast, growth stock investors can hold for the long-term and benefit from the growth of the company. Growth stock investors can succeed with far fewer trades over the course of their lifetime.
- Time works against you. Let's say your goal is to earn 10 percent per year by buying and selling value stocks. Keep in mind that a value company is a company that is growing very slowly -- or not at all -- so the only plausible way to gain a return on a value stock is to buy it below its intrinsic value and sell it when it recovers to true market value. That works great if the stock moves up relatively soon after you buy it, but if the stock doesn't move up for two or three years -- or more -- you're not going to hit your 10 percent return. And the more years that pass before it reaches your target price, the worse your overall return. By contrast, a growth stock that stalls for a couple of years can make up for that time delay with a surge in growth of its earnings that will drive up its price to a respectable gain. It just takes patience -- and that's something the value investor simply can't afford.
- Losers control your returns. If you invest in three value stocks and two meet your expectations and climb 10 percent in an acceptable time frame, but the other one actually drops 50 percent, that can have a devastating effect on your overall portfolio. And unfortunately, the gains of the other two stocks would tend to be moderate and unable to make up for the loss on the third stock. By contrast, if you buy three growth stocks and one drops 50 percent, your gains from the other two stocks that do meet your expectations can more than make up for the loss of the third stock. With growth stocks, the winners control returns while with value stocks the losers control your returns.
- Martin also points out one other potential advantage of growth stocks -- the power of the big idea. You'll never see a value stock grow to a multiple of its current price, but there are hundreds of cases of growth stocks that have done exactly that -- Apple, Walmart, McDonald's, IBM, to name a few. If you had purchased any of these stocks in their early days, their performance would have had a profound effect on your overall portfolio.
For those key reasons -- time is your friend, the power of the big idea, and fewer decisions and fewer trades, Martin maintains that growth stock investing is a far easier and more effective way to succeed in the stock market over the long term.
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