1. Growth stocks derive alpha from growth and future growth while value stocks capture alpha in mispriced stocks.
2. The characteristics of growth stocks (such as rapid rates of growth, sell higher PEs, volatile) are different than value stocks (such as more mature companies, higher dividend yields)
Growth stocks and value stocks have very different performance characteristics. They tend to be complementary because they each perform better during different times in the market, so they offer a different return stream from each other.
Value Stocks: Capturing Alpha in Mispriced Stocks
Value stocks and growth stocks are approached differently typically. When investors are looking at them, when you're investing in a value stock, what you're doing is you're betting on a reversion to the mean. You're assuming that a company that you are looking at is undervalued for some reason, be it technical or fundamental, or some sort of observation with the company where the market is not valuing the company in a way that you think or the investor thinks it should be valued. And as such, you buy into these stocks when they are low, and you wait for the market to recognize that value and try to sell them when they're higher.
Growth Stocks: Alpha from Growth and Future Growth
Growth stocks are different because they're companies that tend to be in the higher growth phase of their buildout. They may be slightly smaller, they may have a new product which is just getting traction in the market, they're doing something that is causing them to grow quickly, and it's more difficult to catch a growth stock super early in the trend unless you're betting on a product or some sort of management-controlled issue. But what you do tend to do when investing in growth stocks is you're joining a trend. The market is usually recognizing the value in that stock. The stock is on an upward trend. That trend tends to be positive and growing quite quickly. So, you're jumping in at a slightly later stage and growing your investment as that stock continues to climb.
There is a profound difference between the two.
Growth Stocks Characteristics
Growth companies are generally growing their sales and earnings at very rapid rates. Most of the time they're making money. Sometimes they're not. They could be deficit companies. They tend to sell higher PEs, and they also are much more volatile than the market as a whole.
Value Stocks Characteristics
Value stocks are typically buying mature companies that seemingly offer good value to the investor. They're propped up by dividend yields. They 100% of the time do have earnings growth, and they also exhibit higher dividend yields.
Example: Growth Real Gains Versus Value Artificial Gains
In the case of any growth stocks, companies that are growing fast, they don't pay out dividends because they take their cash flow and they plow it back into expanding the company. On the other hand, the value of stocks, I'll give you an example. Energy companies, oil and gas companies, don't necessarily reinvest in their businesses because their businesses are at a mature level, and they exhibit unit growth of one, two, or three percent per year because they need to do something with the money. They use it in one of two ways. First, they increase the dividend payout. And second, they buy back their stock. And when companies buy back their stock, there are fewer shares outstanding, which means that you take the same level of profits divided by fewer shares, and lo and behold, the earnings go up. But it's an artificial gain. It's not produced by greater earnings growth or profit margin expansion. It's typically achieved by reducing the float in the number of shares.
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Please note, that the thoughts expressed in this podcast are those of the presenter. This is not, nor should it be considered an offer or a solicitation of an offer for investment.