Investors have fundamentally different ways in which they seek out the stocks they think will provide higher returns on their investment. One particularly wide gulf in equity investing is between value investors and growth investors.
Growth and value are two different strategies of equity investing that seek the same goal for equity—capital appreciation. One way to understand the difference is to look at the emphasis they place on a stock’s price and the company’s earnings, the two elements of a stock’s price-to-earnings (P/E) ratio.
While Value investors are more interested in price, looking for stocks they believe are trading at a discount to their intrinsic value, based on their price, their fundamental strengths, and therefore offer a “margin of safety, and seek to capture gains when economic and market and conditions change, and the price of the stock bounces back.
On the other hand, Growth investors like to buy stocks that are seeing the biggest gains in revenue or net profits. Some Growth investors focus on early-stage small-cap companies that have not even become sustainably profitable yet, seeking out the highest sales growth in the belief that eventually, earnings will follow. Also, other investors look for better-established growth stocks that are already solid yet have further potential to expand their growth. Growth investors focus mainly on earnings, looking for companies with the potential to grow their earnings, revenues or both.
In terms of performance, Growth and Value have swapped leadership roles throughout the ups and downs of various economic cycles and each style is influenced by a wide variety of factors. Outperformance can continue for years, or it can be fleeting.
As a category, Growth stocks perform best during the middle and late stages of an economic expansion cycle, when growth becomes scarce. For example, the recent CBN policy which included Crude Oil Palm (CPO) on the prohibited list of items from accessing FX at the interbank market has seen companies such as Okomu, Presco recording remarkable growth in their earnings. Industry Expert believes there are chances for expansion in the industry. Similarly, the ban on bagged cement importation into the country has seen increased activity in the stocks’ of manufacturers in the country.
The Growth strategy is advisable for established companies that are dominant players in markets that are growing. They may also be gaining market share, which leads to improving cash flows and a healthy return on capital.
Their competitive advantage keeps cost contained and drives demand for their products and services without depending on the benefit of a strong economic tailwind. These companies are usually well-equipped and in some cases to “self-fund” their expansion efforts rather than relying on cheap sources of financing when the cost of borrowing is low.
Value stocks performance is strongest when the economy appears to be approaching a crisis, such as a recession, because the most defensive sectors in the value category tend to be more resilient to economic slumps. The recent economic contraction in the country and slumping crude oil prices in the international market led to a sharp drop in the earnings of some oil stocks on the Nigerian Stock Exchange.
Value tends to outperform after the economy has bottomed out and is starting to accelerate. The fact that value stocks are starting from a lower base than growth stocks also contributes to their outperformance. Within the value category, individual stocks can also surge when a company announces a restructuring or makes another one-time change that lifts its stock price from a relatively low starting point.
For investors seeking the best gains in the Nigerian equities market, the best approach is to find a sweet spot between the two ends of the spectrum. The best stocks combine both growth and value, trading at a reasonable price compared to their impressive growth potential. As an investor, when you find the best of growth and value in a single stock, that’s usually a good sign that you have discovered a great investment.