The investment industry has created categories for professional investors to explain their primary areas of focus and the types of investments they make. Among these categories is the separation of Value Investors and Growth Investors. Juan Espinoza has identified as a Value Investor throughout his professional life as his strategy of investing in overlooked, mispriced, and out-of-favor securities fits perfectly within that category. However, the average investor managing their own money may not be well-served by adopting these labels and may instead want to free themselves from the need to fit into any given category.
Value Investors
Value investors are known to buy stocks or other investments they believe are undervalued. They look for companies or assets whose prices are discounted relative to the market, to peers, or that trade at prices below their “intrinsic value.” “Intrinsic value has been defined in many ways over the years,” Juan says, “but I recommend most people think of intrinsic value as the price a very well-informed buyer would be willing to pay for an asset if they had in-depth knowledge of all the important variables that affect its price, along with a well-researched view of the near and longer-term future of the company or asset.”
Growth Investors
Growth investors seek to invest in companies that exhibit above-average growth in earnings, revenue, or cash flow. An overly simplistic definition would describe them as less concerned with the current price and primarily focused on the potential for future growth. This perception may apply to a fraction of growth investors, but it is not a good representation of most growth professionals, particularly those in large investment institutions. Growth investors typically focus on the rapid increase in revenues and other financial results but see them as variables sensitive to many factors, such as industry trends, product cycles, demand, etc. They are also not inclined to overpay for this growth and conduct diligence that seeks to confirm the lofty assumptions that can be implied in the price of a “growth” asset. Their process is by no means indifferent to valuation metrics and strives to assign a mathematical price to the expected upward trajectory in financial results.
Intrinsic Value and Growth Investing
Returning to the definition of “intrinsic value,” it could be said that growth investors are on their own journey to determine a value that reflects the well-informed buyer mindset mentioned above. Understandably, their process is more weighted toward the “reasonable future” than it is to the present or recent past,” Juan explains, “but the important conclusion here is that they are not indifferent to the price they pay for growth.”
Risk Tolerance
Another area where value and growth investors are typically said to think differently is risk tolerance. Value investors are assumed to be less tolerant of risk, while growth investors are assumed to accept higher risk for the sake of higher growth. “Perceived risk is often in the eye of the beholder and, in the context of institutional money management, it can also be influenced by the level of risk tolerance clients have agreed to take on, regardless of the value or growth label carried by the fund,” Juan says. “In practice, both value and growth investors think carefully about the possibility of downside, loss of principal and underperformance. The main difference in how the two approaches address risk comes from the tools most commonly used to mitigate it.”
Risk Management
In the value realm, the most relied-upon risk management tool is price. The greater the discount to intrinsic value paid by the investor, the higher the tolerance for other traditional measures of risk, such as price volatility. Growth investors face a different set of challenges when it comes to managing downside, as deeply discounted prices can be difficult to find in the growth space. This is why they may need to rely on other risk management tools such as diversification, diligence work, more frequent portfolio rebalancing, dynamic allocation, and, in some cases, portfolio hedging.
Focus on Opportunity
The average investor who does not need to follow the rigid categories imposed by standards in the asset management industry may want to ignore the value vs. growth dilemma and instead focus on spotting opportunity. “Sometimes, the opportunity will come from an old, boring, and deeply discounted company that pays a high dividend, but no one is talking about,” says Juan. “Other times, opportunity may come from a technology company exhibiting rapidly growing market share in a new, emerging product category. Or perhaps it will come from a formerly respected, famous, and fast-growing company that has now fallen completely out of favor and trades at a fraction of its historical price.” To win in investing, staying focused on spotting opportunity is likely the best path to favorable long-term results.
BY Egli HAXHIRAJ, Anamaria MESHKURTI and Jonida GJUZI
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