One of the oldest rivalries in finance dates back to the early 1930s. After the publication of Graham’s Security Analysis, investors split themselves into two teams… team value, and team growth. Every year one group tries to outdo the other in one of those classic battles where it’s hard to call a winner. Instead of getting caught up in labels, what if there was a way to invite both teams together, and have them play nice? What could the value team teach the growth team, and vice versa?
Typically, the value team specializes in buying average companies, but at a very good price. To them, the discount is everything. They look for companies trading at a low price-to-earnings ratio or low price-to-book ratio as a sign of cheapness. Warren Buffett called this the “cigar butt” approach – imagine finding a used cigar butt on the street with one puff left. It’s not pretty, but it’s a free puff. In order to realize value, these investors need to either liquidate the assets of the company, motivate management to change policies, or wait for an external catalyst to return to growth. The process can be long and difficult, but it works over time.
The growth team typically does the opposite of the value team, buying very well-run companies trading at a premium. These companies usually have a much higher return on equity, but can also trade at a higher price-to-earnings ratio or higher price-to-book ratio. So although the growth team holds a fine collection of well-run companies, they risk paying too much for them. Over the span of his career, Buffett is known for having started on the value team, but eventually migrated halfway to the growth team. What could make the world’s greatest investor change his style?
In bringing these teams together, we can show them how cooperation minimizes each other’s errors. That is, the value team would be more successful if they found better run companies, while the growth team would be more successful if they stopped paying too much for well-run companies. In practice, we can do this by taking a company’s return on equity, and then discounting it by what we’re willing to pay for that company. The result is an estimate of the growth investors can expect given their purchase price. Essentially, this hybrid approach combines the best parts of value and growth investing under one roof.
The most successful investors see “value” and “growth” not as two distinct teams, but as a cooperation of forces leading to stronger performance. All of the companies in the Growth Portfolio follow this approach.
Ben Kizemchuk is a Portfolio Manager & Investment Advisor with Altus Securities Inc. in Toronto. He offers financial planning and investment management for high net worth Canadian investors. Ben focuses on high quality investments, the Growth and Income Portfolios, low risk investing, and reducing tax.