Equity Portfolios: Investment Styles

‘Growth’ and ‘Value’ share selection techniques are both ways of using fundamental analysis to find exceptional shares which will outperform the market.

Growth investing focuses on industry sectors and shares which are already doing well but which have the potential to do even better. The approach focuses on analysing companies with rising market price and earnings, looking for the next wave of dominant companies.

Value investing uncovers shares which are currently out of favour but which have the potential to do much better - sleepers or neglected companies.

The terminology is somewhat misleading because both styles are actually looking to discover ‘good value’ shares with exceptional growth potential. But the growth style will select shares which are already rising in price and attracting positive publicity, but are judged to be ‘cheap at any price’; whereas the value approach will tend to buy neglected or scorned stocks which are currently out of favour - shares with a historically low and even falling price.

For this reason, value investing needs a greater emphasis on the financial analysis of balance sheets to find evidence of strong performance potential which the market as a whole has not seen; whereas growth investing relies far more on qualitative judgements about socio-economic and industry trends.

A growth portfolio will often tend to be more volatile across the short term than a value portfolio - as it will comprise of shares with high public visibility which are frequently traded. Value investing tends to steer investors away from popular sectors, so in the short term it will tend to be 'flat', without the highs and lows of the sectors and companies which are the centre of investor attention, rapidly coming into and falling out of favour.

Value portfolios tend to do better in times when the market is not rising fast because when the market is rising fast, by definition, a growth portfolio will do much better. But when a market starts falling, a growth portfolio can crash heavily, leaving a value portfolio as a more 'defensive' short-term performer. Over the longer term, of course, both styles should outperform the market average.

Growth and value styles can also be applied to markets and countries. A stock market which is rising on the back of optimistic economic forecasts is a growth pick - such as the Tiger economies in the early 90s. Anyone investing in them in the late 90s would have been following more of a value style.