Man Measuring Money

Growth investors spend their time trying to identify companies that they believe can grow their earnings in the future.  Their mantra is that rising profits will attract other investors which ultimately pushes up the stock price.  Growth investors focus on younger companies and as a result they often initiate their position when the price-to-earnings ratio is either negative or very high.  They are not overly concerned about the PE ratio because they believe the growing earnings will grow into the valuation bringing the PE down to a more reasonable number.  Ironically, the possibility of rising earnings often poses their greatest risk.  If earnings don’t rise as expected the valuation level can fall and the price of the stock can decline!

In contrast value investors are often more focused on mature companies whose value is being misinterpreted by the market.  Specifically, they seek to buy companies below what their intrinsic value is and hold onto them until the market adjusts and recognizes their real value.  Often these investors are looking at metrics such as Price-to-book, Enterprise Value and Price-to-Free Cash Flow.  The biggest risk for value investors is that a stock can stay undervalued for a long time and as a result that investor can miss out on other movements in the market.

There are successful investors that follow both strategies and many investors combine the two styles adjusting to fit a particular point in the market cycle.  Understanding the risks and rewards of each is an important part of being a successful and disciplined investor!  Which are you?

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