Growth, Value and Quality: Investment Styles You Should Know

If you are investing in actively managed funds with a large equity component, it’s helpful to know the strategies equity investment professionals use to select shares, because, among other things, it partly explains the variability of returns from these funds. Stock-picking strategies can be roughly grouped into a handful of investment styles, of which the most prevalent are growth, value and quality.

Note that some managers’ investment processes are relatively eclectic, blending styles in different ways, while other managers may have a more purist approach to a particular style.

Whatever the style, successful stock-picking requires thoroughly analysing a company’s operations and finances as well as considering the broader economic environment in which it operates. “Bottom-up” investors prioritise the company, whereas “top-down” investors prioritise the broader economic view.

Growth

“The ability to create its own market is the strategic, the dominating, and the single most distinguishing characteristic of a true growth company.” – Peter Bernstein, US financial historian, economist and educator.

Growth stocks are those of young, fast-growing companies, often in rapidly expanding industries employing innovative technology. These stocks may be overvalued, but they reflect investors’ confidence in the company’s potential to prosper and expand. Such companies may not even be currently profitable, and they typically do not pay dividends, as profits are likely to be ploughed back into the company. Thus one would invest for capital growth and not expect dividends to contribute to returns.

Growth investors do not expect all the companies they invest in to fully realise their potential but, like venture capitalists, they expect the high growth of those that do to more than compensate for the ones that get left behind.

A big swing among investors towards growth stocks may push the market into a bubble – a supreme example is the dot-com bubble at the turn of the millennium.

Value

“Price and value are not only different, it is precisely that they can differ widely that creates the opportunities for value investors to earn excess returns. The greater the difference, the greater the potential return.” – Bill Miller, veteran US investor and fund manager.

Value investing is a common investment style among South African investment houses, although they generally take a softer approach than that of a purist value manager. These managers seek out shares of companies that they believe offer greater value than their share price suggests or, in investment terms, companies that are trading below “fair value”. In short, they are looking for bargains.

Fair value refers to the estimated worth of a share based on objective, rational analysis. It’s the price at which a share should theoretically exchange hands, assuming both buyer and seller are well-informed.

Value managers look for anomalies in the market, trying to find shares that are unpopular for no sound reason and that will in time return to fair value. In this respect, they are “contrarian”, often going against the tide of broad investor sentiment.

The softer approach is to blend this style with quality investing (see below) by looking for value among quality companies. However, hard-line value investors disregard quality – their overriding concern is whether the perceived fair value of a company, which may itself be low, is higher than its share price.

This style tends to underperform when markets are soaring, because, as a rising tide lifts all boats, there is little value to be found in a buoyant market.

Quality

“We believe truly exceptional businesses that have established their market-leading positions through competitive advantage can continue to compound those advantages over time more than people expect. We call that mean aversion.” – Stephen Arnold, Australian fund manager.

Unlike growth investors who are interested in the “bright new kid on the block”, quality investors would be more inclined to favour the maxim “slow and steady wins the race”. They look for established companies that are financially robust with reliable revenue flows, low debt levels and strong management teams, and whose growth is steady and sustainable over the long term. These may be your large “blue-chip” stocks, but may include smaller companies with a solid track record.

Quality investors are likely to have defensive stocks in their portfolios – these are companies that provide essential goods or services and are able to withstand economic downturns – making them more resilient.

The companies chosen by growth investors are also likely to have a solid history of paying dividends. With dividends featuring more strongly in returns, these portfolios are well suited to investors needing an income.

Note that the styles are not mutually exclusive – many quality companies fall into the growth and value investment universes. 

REFERENCES/SOURCES

https://www.investopedia.com/terms/g/growthinvesting.asp

https://www.investopedia.com/terms/v/valueinvesting.asp

https://www.lgtwm.com/uk-en/insights/market-views/navigating-investment-styles-what-is-quality-166502