Growth Vs Value Investing
Benjamin Graham, the father of value investing gave us an invaluable advice in buying stocks, “ Buy your stocks, like you buy your groceries, not like you buy perfumes”. The advice is shrouded that most people don’t understand it. In this blog post, we will tell you the intended meaning of that quote and help you with a criterion for choosing your “groceries”.
We shall examine our behavior when we buy groceries for our homes, what do we do? We check for the quality, we ask for the price, as we give importance to our family’s health. Whereas, when we buy perfumes, we don’t give importance to its quality and price, all that matters when buying a perfume is its scent and its attraction.
Benjamin graham, teaches us to evaluate a stock, like how we evaluate groceries instead of falling for the glam of news about the stock”. We now know the meaning of that quote, let us now go back to how to evaluate a stock. Here too, Benjamin graham teaches us to ask how much. Before evaluating a stock, we will know about the different types of stocks, the first one is known as growth stock and the other one is known as value stock. We will know the characters of each stock category
Growth stocks are stocks of a company, that has given above average returns continuously. People flock to these stocks, with the hope of the stock outperforming the sector or the market again. This behavior pushes the stock prices higher. These companies do not offer other corporate benefits such as dividends, as these companies focus on increasing their stock price. They reinvest their profit in their business. Since more people invest in growth stocks, they are highly sensitive to factors like news and are volatile.
Value stocks on the other hand, is available at a bargain, A fundamentally strong company, due to market conditions or corporate issues, may be available at a cheaper price. These stocks form the value basket. These companies give dividends frequently. Since investments in these stocks or less, they are less prone to market volatility.
How to identify these stocks?
All stock investors may have come across the term, “PE Ratio”. But most of us, would not be aware of its meaning. PE ratio is the ratio between price of the stock to its earnings. Let us say, A stock is earning Rupees. 10, if you pay 100 rupees to buy that stock, you are paying 10 times its earnings capacity.
We will use one more example,
There are two stocks “A” and “B”, both are trading at 50 rupees, at the outset, it appears as if both are similarly priced, let us now call upon Benjamin graham, we will now ask “how much?”, Stock A has a PE ratio of 10 and stock B has a P/E ratio of 15. It implies, Stock A is trading at 10 times its earnings capacity and stock B at 15 times its capacity. An investor, should look to buy “Stock A” as it is cheaper in valuation.
Other approach which many investors follow is,
Comparing a stock’s PE with the corresponding sector’s PE, Let us say, A sector (Pharma, for example) is trading at a PE ratio of 35, A fundamentally strong Pharma company, may be trading at 25 PE, Most investors tend to buy that stock as it is “cheaper” compared to its peers.
What can go wrong?
- Investing par se, should be done in fundamentally strong companies, be it growth or value investing.
- Penny stocks can be mistaken for value stocks, weak stocks usually trade at lower prices and they are not suitable for value investing.
- Before we plan to buy a stock, we have to know what trend the stock is in! investing without understand that can be dangerous.