Balancing value and growth
Joel Dresang: Brian, when we talk about diversifying an investment portfolio, we talk about stocks versus bonds. But we also talk about diversifying within that stock portion. Can we talk a little bit about value stocks versus growth stocks? And let’s start with a definition.
Brian Kilb: Joel, I think the easiest way to get your arms around the difference between value and growth stocks is just to look at it in valuation terms.
If we were to take the average price-to-earnings ratio in the market at any given time, value stocks would be the cheaper side of the equation. So, anything with a price-to-earnings ratio less than the average of the market place, often is considered the value side.
Conversely, anything with a price-to-earnings ratio greater than that average would often be considered the growth side.
Joel: Are there benefits that one has over the other – value versus growth?
Brian: They perform differently, but the characteristics that each side have become important in terms of building a well-diversified portfolio. We often think of value stocks as having a lower risk, lower return potential. On the growth side you just get the opposite. Maybe you’ll make a little bit more money, but there’s a greater risk for the potential to earn more.
Joel: Do different times in the cycle favor one over the other?
Brian: Typically, earlier in the business cycle when the recovery is beginning anew and the economy is growing – the rising tide lifting all boats. Since you’re paying less for value to begin with and you’re getting growth as a result of economic growth, oftentimes, value will be favored in that part of the cycle.
Later on, when things start to slow down a little bit, you may have to focus on the growth side of your portfolio. Pay up a little bit, perhaps, to get that growth, which is somewhat disconnected, perhaps, from the growth in the economy itself.
Joel: And value stocks tend to have dividends more often than growth?
Brian: Most of the dividend-paying companies are often on the value side of the equation typically because of the types of industries involved: more mature industries like banking, like manufacturing.
The growth companies have a tendency to take that profits or additional money and reinvest it back in the company for growth.
Joel: So they grow more, but there’s more risk involved?
Brian: Well, they’re trying to grow more. They don’t always grow more. As an example, you might look at the auto manufacturing industry. You know, worldwide Joel, we have a pretty good idea how many cars we’re going to manufacture and drive in the world. The differentiation between the good companies and the bad companies might be subtle nuances between “we sold a little bit more here, a little less there.”
But really nothing’s going to motivate you to buy three times as many cars as you planned on at the beginning of the year. So the potential for return in the auto manufacturer isn’t as great, perhaps, as something on the growth side like technology, as an example. Like pharmaceuticals, as an example.
You may have six or seven companies vying over the next generation of whatever drug might be in the pipeline. Well, the one company that gets there first may reap great profits, and you as an investor may share in those profits. The other six, perhaps not so much.
Joel: So it’s not either or. It’s not value or growth. Everybody should have a little bit of each?
Brian: I think there are certain attributes to both that play to the needs of the investor. Part of it is a personal preference as well. I think if you have a greater tolerance for risk, then you’ll have a greater tolerance perhaps for growth stocks in your portfolio.
Certainly, I think it’s fair to say most of us, as we get older, have less tolerance of risk because the day we’re going to need that money gets closer, and we don’t like the roller coaster ride.
Joel: What about in my international stock portfolio, should I also be looking at value and growth there?
Brian: Absolutely, yeah. The same concepts would apply whether we’re – whatever industries may comprise the domestic part of your portfolio as well as the international side.
Brian Kilb is executive vice president and chief operating officer at Landaas & Company.
Joel Dresang is vice president-communications at Landaas & Company.
Money Talk Video by Peter May
(initially posted March 21, 2014)