Investors have long separated themselves into one of two camps for how to build wealth: value investing or growth investing. Though these strategies overlap more than they differ, for a long time, investors have treated growth or value approaches as opponents in a boxing ring: feeling like they could only support one or the other.
But Howard Marks of Oaktree Capital Management, one of the most well-established value investors in the financial industry, had a realization during the 2020 roller coaster that value and growth strategies are not so divergent after all.
During that time, his son Andrew, a professional investor committed to the growth strategy, helped him understand the benefits of growth investing. If such a committed value investor as Howard Marks can rethink his approach to investing after a tumultuous year, then it’s worthwhile for all of us to understand the benefits and drawbacks of each of these investing styles so we can make the best investing decisions for ourselves.
In a recent memo for Oaktree Capital, Marks explained in detail what helped him to see his value investing philosophy in a new light. During the pandemic, Marks and his wife welcomed their son Andrew and his small family into their home for 10 months of 2020. Living in close proximity allowed Marks to see how Andrew made his investing decisions during one of the most turbulent market years in recent memory.
Marks, who comes at investing from a conservative viewpoint, realized that his insistence on several of the hallmarks of value investing meant losing out on important investments. He writes:
“Part of what makes up the value investor’s mindset is insistence on observable value in the here-and-now and an aversion to things that seem ephemeral or uncertain...value investors [tend] to be very skeptical of market exuberance, especially when concerning companies whose assets are intangible. Skepticism is important for any investor; it’s always essential to challenge assumptions, avoid herd mentality and think independently. Skepticism keeps investors safe and helps them avoid things that are ‘too good to be true.’
“But I also think skepticism can lead to knee-jerk dismissiveness. While it’s important not to lose your skepticism, it’s also very important in this new world to be curious, look deeply into things and seek to truly understand them from the bottom up, rather than dismissing them out of hand. I worry that value investing can lead to the rote application of formulas and that, in times of great change, applying formulas that are based on past experience and models of the prior world can lead to massive error.”
Value investors’ overreliance on formulas seems particularly concerning in 2021, as we are clearly in such a time of great change. Marks’ recognition of this potential pitfall of the strategy he has used for the entirety of his illustrious career is an excellent reminder of how savvy investors have to be open to new ideas, plans, patterns, and strategies.
So how does the average investor balance value vs. growth investing in their own portfolios? It starts with a thorough understanding of what these strategies are and why they are used.
At its heart, value investing is a conservative investment strategy that is all about seeking “hidden gems.” Value investors want to purchase shares in a robust company that is currently undervalued. To determine the company’s value, investors will look at a number of metrics, including:
In general, a value investor will focus on stocks with a low p/e ratio, a current stock price below the DCF, and high dividend yields. That’s because these metrics together tend to indicate that a stock is currently undervalued, and can be purchased at a discount.
Value investors are also interested in making purchases of solid companies in the wake of market downturns. You may have heard investors crowing about “stocks going on sale” after the bottom dropped out and most people were panicking about their portfolios back in March 2020. At that time, value investors were well aware that major players were going to bounce back from the market tumble, so they purchased stocks while they were temporarily undervalued.
Ultimately, value investors want to feel confident that they are making a good investment that is unlikely to drop in value in the future.
If value investing starts in a place of caution, growth is all about taking calculated risks. Growth investors aren’t as interested as hedging their bets as their value-oriented counterparts, because they want to be able to take advantage of unlimited growth potential, rather than put guardrails around their potential losses.
Growth investors will also look at the metrics of their potential investments, but they have different criteria for their decisions. Generally, high p/e ratios don’t frighten growth investors, as they only choose stocks in companies they anticipate will go gangbusters, even if the price is already high. These investors are also less likely to use DCF to make their investment decisions since they are focusing on companies whose future cash flows are not necessarily predictable. And growth investors would prefer not to receive high dividends, as growing companies need all of their available cash to reinvest into the business to continue expanding.
While value investors want long-term, guaranteed returns on their investment, growth investors are more interested in jumping on investments with an upward trajectory, even if they are already priced relatively high.
While it may seem like value and growth investing are diametrically opposed—and that is certainly how these two strategies are often presented in financial media—they are both fundamentally trying to do the same thing: buy low and sell high.
Value investors have a more specific dollar amount in mind when buying low. They are more likely to be turned off by a high stock price on an investment that is trending upward. But growth investors recognize that “low” does not have an absolute value, and sometimes you have to buy stock at a relatively high price because it’s only going to get even higher as the company takes off.
The difference really comes down to what each investor feels confident about. Value investors trust in their formulas and their system, which seeks out and purchases undervalued stocks, rebalances them when their p/e ratio gets too high, and trusts that dividends will help increase their wealth. Growth investors are more likely to trust in the ability of individual companies to grow, as well as in their own ability to recognize when to sell.
Marks illustrated this beautifully at the end of his memo, where he related a conversation he and Andrew had about a company that was doing incredibly well--to the point where Marks would have sold it. Marks was trusting in his investment plan, while Andrew trusted his insight about an investment in a particular company. When Marks asked Andrew if he would rebalance his portfolio now that the company’s p/e ratio had gotten very high, his son responded:
“[That] would mean selling something I feel immense comfort with based on my bottoms-up assessment and moving into something I feel less good about or know less well (or cash). To me, it’s far better to own a small number of things about which I feel strongly. I’ll only have a few good insights over my lifetime, so I have to maximize the few I have.”
Even if you are not a professional investor like Howard and Andrew Marks, you can still re-create the level of confidence and certainty about your investments that they both enjoy. You can start by choosing ETFs that replicate the specific growth or value markers that are most important to you can help you build wealth and meet your financial goals. From there, maintaining the level of curiosity and willingness to re-evaluate your strategy that Marks recommends can help you stay nimble and able to change tactics when circumstances change.
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