Friday, July 10, 2015

Value and growth investing...

From The Small-Cap Advantage: How Top Endowments and Foundations Turn Small Stocks into Big Returns:
A common misperception among professional investors is that there is a bright-line distinction between value and growth investing. This is a legacy belief that was driven largely by institutional consultants. They have attempted to group managers whose portfolio characteristics clustered around low prices in relation to book value and earnings as value managers. Conversely, a manager with a portfolio filled with companies that exhibit growth in sales or earnings are considered growth managers. If a small-cap manager engages in fundamental company analysis with any regularity, the irrationality of this model becomes readily apparent. Growth (or lack thereof) is simply incorporated into the mathematics of appraisal. No manager, growth or otherwise, is attempting to purchase a security at a steep premium to estimated appraisal. The industry perpetuates the myth that value managers are concerned with buying statistically cheap securities and that growth managers do not care what they pay. Nothing could be further from the truth. 
The previous section included a discussion on the pros and cons of relying on historical accounting data for valuation. Appraising an operating business is almost always about the future profits attributable to owners. If expected profits are discounted appropriately and adjusted for capital structure, then an appraisal should reflect all variability within the various line items on the income statement. Both value and growth managers are correct to attempt to purchase at a discount to appraisal. Conversely, both are likely to be wrong if, in the case of value managers, they blindly purchase stocks with low relative price-to-book values without considering the future of the company and, in the case of growth managers, they blindly purchase fast-growing companies regardless of valuation.