Let me start with basics. What is investing? In lay man terms, investing is about delaying current consumption, deploying that money into assets to get something in return for the postponement of current consumption and increasing the purchasing power in future which is basically wealth creation.
Being an equity research analyst,Let me come back to equities. An equity or share represents a part of ownership of business so investing in equities requires thorough understanding of business. Investing in equities is a combination of art and science, as it requires thorough analysis, preservation of capital and adequate returns.The next question which is core of this write up is what is the difference between value investing and growth investing?
There are no such labels for investors to classify themselves “I am a value investor” or “I am a growth investor”. To classify yourself into value investor or growth investor would be naïve because ultimately the main focus should be to create wealth. Even a value investor needs growth in earnings for value to materialise and a growth investor would love to underpay if he can get that same thing at a cheaper price, the difference is only in approach. Value investing is conservative while growth investing is aggressive. Let us shift our focus back onto what is value investing and growth investing
Value investing is basically paying less for something than what it is worth to us. Consider an example where you go in a grocery market to buy vegetables. The thing you will commonly observe is that for a similar quality of potato which is available at 20Rs per kg in the market, you would ask and always prefer to pay 15 Rs per Kg and your utility for potato will increase if similar quality of potato is available at 10 Rs per Kg. This is value investing. Let’s understand it in terms of business,suppose there are two companies A and B. both generates sustainable cash flow and PAT of 100. Both companies are expected to grow their PAT at 15% for 5 years. A is available at a price of 1000 while B is available for 1500. 5 years down the line both the companies would be earning PAT and cash flows of 200. If both the companies are available at same price then A is yielding 20% and B is yielding 13%. The obvious conclusion would be to buy A. This is value investing. The thorough analysis of understanding businesses comes in picture to come up with the cash flows company can generate 5 year down the line.
Growth investing is basically betting on higher expected growth rates and being inconsiderate about relative valuations with the focus on capital appreciation. This kind of investing focuses on high quality businesses with higher expected growth rates in future with the belief that higher growth will drive the returns. Returns are the factor of earnings growth and valuation multiple expansions. Suppose a company earning sustainable cash flows of 100is valued at 5000. So the P/E multiple is 50. A growth investor upon thorough analysis believes the company can grow its cash flow at 30%. At 30% growth rate, Company will be earning 371 in 5 years and so should be valued at 18500 i.e. 30% return over the period at P/E multiple of 50. The risks in purchasing businesses at high relative valuations is the risk of high expected growth rates not materialising and multiple contractions which can be a dent on small size portfolios and can lead to permanent loss of capital.
I am particularly inclined towards the value investing approach as the main focus of the approach is preservation of capital. No approach is good or bad in itself. There are different characteristics of both the approaches and ultimately the goal is to find high quality businesses with huge earnings growth potential at cheap prices.In the end I would like to share one famous quote ofSir Warren Buffet “Its far better to buy wonderful business at fair price than a fair company at wonderful price”