Value vs. Growth

The financial community has a tendency to put stocks into specific categories for reasons of comparisons, although it may not be appropriate. One of such common divisions is value vs. growth. What they generally call “value” stocks is what I call “cheap” stocks, and what they generally call “growth” stocks is what I call “expensive” stocks. One of the frequently used measures to separate the value stocks from the growth stocks are low P/E ratio, high B/M ratio, and low dividend yield. Stocks with opposite characteristics are called growth stocks.

Just because such ratios make it easy for researchers to collect data from their database doesn’t mean that it can be used to make a conclusion, “Value stocks have performed better than growth stocks in the past”. Rather, it should say, “Cheap stocks have performed better than expensive stocks in the past”, which sounds obvious since stock price tends to converge to its intrinsic value in the long term. In the long term, the price of the cheap stocks goes up and vice versa for the expensive stocks. Then there’s no need for you to scratch your head and figure out why the “value” stocks have performed better than the “growth” stocks, and you can save much of your brain power and time.

From my point of view, first, the growth stocks should be defined as stocks that will grow in the future, not the ones that have grown in the past. For example, if a company XYZ has grown rapidly in the past and there is only small room for it to grow down the road, then it should not be called “growth” stock just because it has grown fast in the past, or just because the financial community assigned it high P/E ratio, low B/M ratio, etc. In addition, the value stocks should be defined in that its intrinsic value (i.e. the present value of all the future cash flows) is well below the market price, not the ones with low P/E, high B/M, etc. What determines the stock price in the future is its future performance, even though it is hard to quantify.

Second, the growth stocks are in the subcategory of the value stocks, not the two independent things. In other words, the growth is just one of many elements that can be used to derive the value of a company. Therefore, in many cases, great growth stocks are the great value stocks.

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