Investment Management Assignment

What is growth investing?

Growth investing is a strategy in which the focus is on capital appreciation. It involves
investing in companies which have above average growth potential in the future even if the
price of the share is on the higher side in terms of PE ratio or PEG ratio. The fundamental
premise is that growth in earnings and/or revenues will push the stock prices higher up in
the future. Growth companies are expected to have a competitive advantage over their
competitors either in the form of a product line which is expected to sell in the future or
these companies are better managed or run and thus they should gain an edge over other
companies in the market.

What is Value Investing?

Value investing is based on the premise that one should invest in those stocks in which the
current price does not actually reflect the full potential which the company might have to
produce future income and growth. Some investors feel that these companies have enough
potential in them and because of some current reasons the stock price is below than what it
should be. Some investors have defined the value investing as opposite of growth investing
and should include stocks and companies which are not growing well hoping that there
would be a reversal in the trend and would start increasing in the stock price.

Investors see these stocks as undervalued and that could be because of a number reasons
from bad press or a scandal performed one of the top management personal in the
company. But if the fundamentals of the company are strong enough, it will eventually
perform as the market will forget these one-off instances. In these cases, the price will again
gain back.

Some of the characteristics of a value stock are as follows-

 The price-earnings ratio (P/E) should be in the bottom 10% of all companies.
 The price to earnings growth ratio < 1, which would indicate that the company is
currently undervalued
 Current assets should be around twice the current liabilities.
 The current share price of the stock should be at tangible book value or less than
that.

How to pick up growth stocks? i.e. criteria for picking up growth stocks
Growth investors look at five key factors when selecting companies that may provide capital
appreciation.
Management's Management's Potential in the
Strong historical earning Forward earnings
control on costs way of operating assets to be
growth growth
and revenues the business doubled in 5 years
 Strong historical earnings growth. In the past five years, the company should have a
track record of strong earnings growth. The minimum EPS growth depends on the size of
the company: for example, growth of at least 5% for companies that are larger than $4
billion, 7% for companies in the range of $400 million to $4 billion and 12% for
companies which are smaller than $400 million. The basic premise is that if the company
has displayed good growth in the recent past, it’s likely to continue doing so moving
forward.

 Strong forward earnings growth. Companies which are having strong forward earnings
growth potential would likely to see an increase in the stock price in the future giving
better returns to the investor in comparison to the industry.

 Strong profit margins. A company could have a good growth in its sales but could earn
poorly in earnings. Such a situation would indicate that the management is not
controlling costs and revenues. In general, if a company exceeds its previous five-year
average of pre-tax profit margins – as well as those of its industry – the company may be
a good growth candidate.

 Strong return on equity. A company’s return on equity (ROE) measures its profitability
by revealing how much profit a company generates with the money shareholders have
invested. One should compare a company’s present ROE to the five-year average ROE of
the company and the industry. If the company is having stable or increasing ROE then it
would mean that the management is performing well and is generating returns from
shareholders’ investments and the business is being managed efficiently.

 Strong stock performance. In general, if a stock cannot realistically double in five years,
it’s probably not a growth stock. To double in five years, the growth rate must be 15% –
something that’s certainly feasible for young companies in rapidly expanding industries.

What type of businesses/industries/companies are best suited for growth investing?

The following are the four different

categories of growth investment vehicles in Blue chip
Smaller companies
which investors would invest in one or more companies
of these categories. Growth investors like to
buy stocks which are gaining a lot in either Investment
revenues or profits or both. Some investors Vehicle
focus on small-cap companies which are in
initial stages that often haven't even become Emerging markets Recovery shares
sustainably profitable yet, seeking out the
highest sales growth in the belief that
eventually, earnings will follow. Other investors look for better-established growth stocks
that are already solidly in the black yet have further chances to expand their reach. Growth
investors typically look for investments in rapidly expanding industries where new
technologies and services are being developed and look for profits through capital gains and
not dividends – most growth companies reinvest their earnings rather than pay a dividend.
Growth companies are expected to expand quickly in the future thus yielding higher growth.
Investors also look at investing in promising stocks in the emerging countries because these
economies would have a huge growth potential and would give better returns in the future.
Investors are also looking at the industries which have had a dull phase in the past and now
are recovering with fresh demand or a technological development or because of other
economic reasons would grow well in the future.

How is growth investing different from value investing? Are the two totally different
genres, totally unrelated?

Growth Investing Value Investing

Relatively high P/E ratio and price to book Relatively low P/E ratio and price to book
ratio. ratio.
Growth stocks underperform during bear Performance of value stocks are in the
markets and outperform during bull middle in both the cases.
markets.
In growth investing, the investors want high In value investing, the investors want low
earnings growth rates and little to no P/E Ratios and high dividend yields.
dividends.
Growth stocks must rely solely on the The total return of value stocks includes
capital gain (price appreciation) because both the capital gain in stock price and the
growth stocks do not often produce dividends received.
dividends.
Growth investors typically endure more Value investors have less volatility because
volatility because there are no dividends. there are dividend payments as well which
is more reliable.
The two strategies are not totally unrelated to each other because a prudent investor would
use the mix of both the strategies and an investment to give above average results they
should either be growing very well or should be slightly undervalued (for their potential) or
mix of both. Also because the objective of investment could be very different from investor
to investor and so could be the time horizon or risk appetite.

Which strategy-growth or value- performs better than the other?

Over the longer-term history of the stock market, value stocks have had an edge. From 1926
to 2016, value stocks returned an average of 17% annually, compared to 12.6% for growth
stocks. Since the past 10 years, Growth stocks has dominated the value stocks which can be
seen evident in the iShares Russell 1000 Growth ETF (NYSEMKT:IWF) producing total
returns of 174% since 2008, compared to just 100% over the same 10-year period for the
iShares Russell 1000 Value ETF (NYSEMKT:IWD). Using other fund families to compare leads
to similar results. For instance, comparing two major growth and value ETFs from Vanguard,
growth beats value 163% to 117%. From 2007 to 2013, growth stocks posted higher returns
in each cap class.
The best stocks combine both growth and value, trading at a reasonable price compared
to their impressive growth potential. When you find the best of growth and value in a
single stock, that's usually a good sign that you've discovered a great investment. The
growth-versus-value debate is ultimately dependent upon the investor’s risk tolerance,
investment objective and time horizon as well as the current state of the market. It should
also be noted that over shorter periods, the performance of either sub-sector will depend in
large part upon the point in the cycle that the market happens to be in. For example, value
stocks tend to do better during recessions, while growth stocks will often outperform during
strong periods of expansion. This factor should therefore be taken into account by shorter-
term investors or those seeking to time the markets.
How has growth investing (or growth funds) performed in India?

From 2005 to 2012,

the value index
outperformed the
growth index in
most years.
However, post
2012, growth index
has outperformed
value index. In the
last 5 years, MSCI
Growth Index has
given 12.35%
annualized returns,
while MSCI Value
Index has given
only 8.7%
annualized returns.

MSCI Growth Index

outperformed MSCI
Value Index over
the last 5 years. But
if consider the
growth of Rs 1 lakh over the last 14 years has been almost the same in Growth Index and
Value Index. However, for most parts of the last 14-year time-frame, value index
outperformed. In an investment cycle, we will see both and therefore, there will times when
growth stocks will outperform value stock and vice versa. The returns which have been
generated by both the strategies are quite similar and the results are a testimony of that.