“We believe that durable, cash-generative franchises are rare and undervalued by most investors for most of the time … People will still be using Dove deodorant, drinking Johnnie Walker or eating Cadbury chocolate whatever happens...”
"Forrest Gump is rewarded for his determination and resilience in the face of vicious storms. We believe returns could be bountiful for the genuinely long-term and patient value investor too."
Nick Kirrage, fund manager, Schroders
Traditionally, investment styles fall into two broad categories: growth and value. While the end game for both is to get a return on the investment, the ways of going about that are quite different. The rivalry between the two camps can be intense, each side convinced that their method is superior. To complicate matters, there’s also a middle ground, most notably the unpleasant-sounding GARP, which actually stands for “growth at a reasonable price” rather than a digestive complaint.
So how can you work out which style is best for you? Or whether you have to make that decision at all? First we need to understand the two methods.
In the main, growth investors look for companies which will be successful in all economic environments. Boom or bust, these firms can keep growing sustainable sales and/or profits because they have a unique product or service which others find it hard, or impossible, to copy. Other variations of the growth style include investing in companies which can grow faster than their peers, or the market overall, or concentrating on more uncertain areas such as emerging markets and small, less-established companies.
Ideally, a growth fund manager should be able to spot a unique company before other investors realise it has the potential to become mainstream. This is why technology is such a fertile area. But it’s not just start-ups with the wow factor. Household names with consumer brands, for example, which can reliably chuck off even single percentage figures of growth every year, can still be considered growth stocks.
Notable growth investors in history include Thomas Rowe Price, whose eponymous company is now a major financial services provider, and Philip Fisher, whose 1958 book Common Stocks and Uncommon Profits remains the primary resource. In more modern times, Nick Train (as quoted above) and Terry Smith are pre-eminent growth investors.
Value investing takes a different approach. The typical value fund manager, such as Nick Kirrage (quoted above), is looking for hidden gems: unloved companies which have the potential to recover strongly given the right catalyst.
As with growth, the term value encompasses quite a few subsets. One value manager might be looking for quality firms whose share price has fallen below its intrinsic value only temporarily. Another might take a “contrarian” or “deep value” approach by investing in firms which have lost their way but can get back on track with a revamp of product offering or new management. Lastly, some managers may “bottom-fish” among distressed corporates for overlooked revenue streams or assets.
The value style was pioneered by US economist Benjamin Graham. His second book, The Intelligent Investor, published in 1949, inspired his most famous student, Warren Buffett, currently the world’s most successful investor.
In contrast to growth companies, the economic environment is very important to value firms which traditionally fare better in an upturn. The banking sector, for example, is a popular hunting ground for traditional value investors as they find it difficult to make money when interest rates are low (usually in a downturn). Again, this could be an opportunity for the value investor to buy banking shares cheaply if they have enough conviction that, once the cycle turns and interest rates start going up, those share prices will too.
While both investment styles sound impressive in theory, each has its own drawbacks in practice.
For growth investing, the major hurdle is that you could overpay. In troubled times, those companies making any kind of money become the only game in town and investors pile in, inflating the share price to beyond the true value of the company. Some investors play the phenomenon by “momentum investing” in only those shares which are rising in price and then selling the minute they peak (assuming that point can be timed).
Nor are growth companies completely immune to the economic cycle, particularly the impact of interest rates. Should interest rates begin to climb, investors’ appetites for growth companies may wane and their share price fall.
Meanwhile, the unlucky value investor can be left waiting for a catalyst which never arrives. This is known as the "value trap". Some things, sadly, are cheap for a reason: there’s no knight coming to the rescue and the company eventually slides into obscurity, along with your investment.
There are times when both styles perform well in the cycle. Over long periods in history, value has proved to have the edge, markedly outperforming growth in the hundred years to 2007. However, with central banks keeping interest rates low or near zero since the global final crisis of 2008, growth investing has gained the upper hand, according to recent research by Brewin Dolphin and data from Thomson Financial Datastream. Indeed, at the time of writing, the gap between returns from growth and value was at its widest point for 25 years, nearly 450%. Predictably, some commentators have sounded the death knell for value investing while others interpret the divergence as a signal value stocks are soon to rebound.
For the individual investor, deciding between growth and value isn’t as tough as it looks. In reality, most fund managers use a blend of styles: growth managers must understand the “real” value of their investments to avoid overpaying and value managers rely on some kind of growth for their targets to return to favour. Warren Buffett, who is generally thought of as a value investor, actually treads the middle ground. He summed up his position by saying: “It's far better to buy a wonderful company at a fair price than a fair company at a wonderful price.”
Another solution can be found in one of the golden rules of investment - diversification. Investment styles come in and out of fashion and it’s very hard to predict when that happens. Spreading your investments between managers of both styles should mean that at least some of your money will be on the winning team at any given point in time.
The information in this post is not financial advice, it is provided solely to help you make your own investment decisions. If you are unsure about whether an investment is appropriate for you, please seek professional financial advice. You can find more information here.
When you invest you should remember that the value of investments, and the income from them, can go down as well as up and that past performance is no guarantee of future return.