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What's the difference between Growth and Value investing?


DooDiligence

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This is already known by most people here, but I thought Buffett's explanation was excellent, as well as entertaining. If you're like me, you also don't mind hearing something you already know, just to reinforce the idea(s).

 

www.reddit.com/r/brkb/comments/lugji6/warren_buffett_recites_a_600_bc_investment/?utm_source=share&utm_medium=web2x&context=3

 

or you can go directly to the youtube video

 

 

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P.S. I posted this here because I didn't want to detract from the recent BRK letter discussion by posting in the BRK section. God knows I derail enough discussions.

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This is already known by most people here, but I thought Buffett's explanation was excellent, as well as entertaining. If you're like me, you also don't mind hearing something you already know, just to reinforce the idea(s).

 

www.reddit.com/r/brkb/comments/lugji6/warren_buffett_recites_a_600_bc_investment/?utm_source=share&utm_medium=web2x&context=3

 

or you can go directly to the youtube video

 

 

---

 

P.S. I posted this here because I didn't want to detract from the recent BRK letter discussion by posting in the BRK section. God knows I derail enough discussions.

 

I liked the video, I haven't heard the aesop analogy.

 

My one comment is that people think of growth and value are two points of the opposite spectrum in one dimension. It is not.  But can we say they are orthogonal? I thinkso...

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In a Platonic ideal sense, they are the same. The concept of IV being a very "pure" idyllic concept. (Since no one can predict the next 70 years of any business, I don't care what it is and who you are.)

 

In reality -- in practice --  I have made a useful, non-blurry distinction.

 

Growth focused investors are primarily looking to benefit from the growth in the intrinsic economic value of the company over time, as measured by whatever KPIs you'd choose - cash flow, earnings, revenue, margins etc.

 

Value focused investors, from the early days, focused a great deal more on determining today's fair economic value and trying to buy the stock at much lower than that number, and sell it when it got close to that number.

 

The way the style indexes do it is pretty much nonsense - low P/B ratios and that kind of thing.

 

But I think there is a real difference between the two above and my experience lately has been that many have soured on the discount-from-value approach (as I've described it) and many more have chosen the ride-the-economic-growth approach.

 

You can, of course, find a hybrid strategy - but acknowledging that pretty much confirms that there are two (or more) things to hybridize.

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In a Platonic ideal sense, they are the same. The concept of IV being a very "pure" idyllic concept. (Since no one can predict the next 70 years of any business, I don't care what it is and who you are.)

 

In reality -- in practice --  I have made a useful, non-blurry distinction.

 

Growth focused investors are primarily looking to benefit from the growth in the intrinsic economic value of the company over time, as measured by whatever KPIs you'd choose - cash flow, earnings, revenue, margins etc.

 

Value focused investors, from the early days, focused a great deal more on determining today's fair economic value and trying to buy the stock at much lower than that number, and sell it when it got close to that number.

 

The way the style indexes do it is pretty much nonsense - low P/B ratios and that kind of thing.

 

But I think there is a real difference between the two above and my experience lately has been that many have soured on the discount-from-value approach (as I've described it) and many more have chosen the ride-the-economic-growth approach.

 

You can, of course, find a hybrid strategy - but acknowledging that pretty much confirms that there are two (or more) things to hybridize.

 

I agree that Growth and Value investing are different things, but disagree with that distinction.  Instead, I'd define Growth focused investing as those oblivious to an investments intrinsic value, and relying on its high rate of growth to bail you out. Where-as Value investing applies margin of safety to all investments that have a reasonably estimate-able intrinsic value, including growth companies, and uses that discipline to out-perform.

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To me a useful analogy is real estate.  Are you a "cash flow" investor or an "appreciation" investor.  One (as I understand it) likes good income to price ratios and buys off the beaten path, one buys stuff in hot markets and bets on continued appreciation for their gainz.

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A "value" thesis typically relies on regression to the mean.  It goes wrong when there is no regression to the mean, just continued progression toward zero (the "value trap").

 

A "growth" thesis typically relies on the business being able to stave off regression to the mean for some amount of time.  It goes wrong when the progression from the mean stalls out too early (or never materializes to begin with).

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A "value" thesis typically relies on regression to the mean.  It goes wrong when there is no regression to the mean, just continued progression toward zero (the "value trap").

 

A "growth" thesis typically relies on the business being able to stave off regression to the mean for some amount of time.  It goes wrong when the progression from the mean stalls out too early (or never materializes to begin with).

 

The corollary is that "value" style is more practiced in credit analysis where guys are focused on minimizing downside protection because their upside is getting their principal back.  They underwrite to past stresses and trough profit margins, assuming those will be revisited.  "Growth" style is practiced more in the tech world where everybody is trying to invent new things or new business models to move away from the past.  We've been living in a period of tremendous changes brought on by the advent of internet and mobile phones - ergo the dramatic underperformance of value vs. growth. 

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The main problem with traditional value investing now is that many (if not most) of the cheap stuff is in the non-internet economy and losing market share every year. It's a melting ice cube even if it's a well run one. You can be right on the valuation part but lose your shirt as the business struggles harder and harder even to just stay where it is. The problem has become a meta one.

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Growth investing is all about scaling up to boost operating leverage; unit costs dropping faster than sales price cuts to increase margins, P&E contracted out wherever practical to minimize fixed overhead, etc. Grow the networks you are on, &/or acquire and fire. Prune aggressively as you go.

 

Investment folks screw it up, by discounting future cash flows at k-g. Sh1tty forecasts (vs eventual actuals) discounted at ultra-low rates to maximize the capitalization value; higher the growth rate the worse the problem. Hence you're betting on the underlying company, and against the investment community. The perfectly good company, mauled simply because the growth rate faltered for a period. Ideally bought with the gains from an opportune put.

 

There is a reason why growth companies are primarily either tech or pharma.

 

SD

 

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Thanks for all the contributions.

 

My takeaway is that growth & value are joined at the hip, but markets can cause dislocations.

 

I prefer a proven track record and tend to look at historical performance & then make a guess as to whether the business can continue doing what it does, better than the competition. I do this at an amateur level and rely a lot on luck. I don't do cash flow projections because GIGO. Does it look like a value based on historical metrics? Am I looking at the correct metrics based on the type of business & the capital structure?

 

I've lucked up and found growth in Edwards Lifesciences (owned since 2013), Novo Nordisk (2016), Fresenius (2021), Dominos (2021), Roper (2021)

 

Historical growth at least, and with EW, NVO & DPZ, it's been mostly organic.

 

I realize this may or may not continue with any or all of these, and whether or not I've paid too much for the latest purchases remains to be seen. Grow or no grow? Will Roper have to compete with CSU for acquisitions now? Will purchase premiums continue to rise for enterprise level software businesses? Will people stop eating pizza? These are the questions that don't keep me up at night, for now.

 

 

and then there's Berkshire (owned since 2017). I know, I know, Berkshire's not a growth stock but hey, they went from:

 

2010 total revenues $136B, earnings $13B, EV $215B to

TTM total revenues $279B, earnings $35B, EV $623B

 

if that ain't growth, I don't know what is,

and the markets yawn.

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