Growth vs. value stocks
One question you can ask yourself before you invest in a company: why do I think the value will increase and provide a good return on my investment?
One reason is because the company is poised to grow at a rate above the overall market. These are called growth stocks.
Another reason is because the company is valued lower than it should be right now based upon a fundamental analysis of its fair market value. These are called value stocks.
Growth
With a growth stock, the current price may already be high due to strong demand, because people think the stock will be worth much more in the future. That is the risk you are taking, because if the stock does not outperform the overall market, you are now behind.
Having a good knowledge of the market in which a growth stock company operates is very helpful. There may be market disruptions (AI anyone?) that lead to outsized expected growth. Look at Nvidia’s 5 year chart. Tell me when everybody figured out Nvidia’s chips were amazing for AI processing.
Or Amazon during the pandemic. Look at this chart and tell me when everybody figured out that if you can’t go to the store to buy things, you are going to need to order it online.
These companies were sitting in a market that, for whatever reason, had amazing growth potential. The companies were able to use their core strengths to jump ahead of the overall economy in terms of value creation speed.
Value
As mentioned, value stocks are those that, after lots of research into the company and market itself, you think the price of the stock should be higher than it is right now. And you expect that stock price to rise as everybody else realizes all the amazing things you already realized.
The stock could have been beaten down by some newsworthy event, which caused everybody to panic sell. These stocks are trading nowhere near their high marks. However, if you think the stock will get back up to that high water mark, you may have found a good value stock.
Now, determining which stocks that have suddenly dropped in value are actually value stocks takes research. You don’t want to “catch a falling knife” by the blade and end up bloody. You want to be able to catch the handle! Does the company have enough cash to weather any storm? Are creditors piling up? Is the photograph printing market shrinking incredibly fast and the company is not making the right decisions? Back to that fundamental analysis of the company itself - if you look at the financials and are impressed with the leadership's team ability to navigate that quick drop in stock value, then you found a winner!
Warren Buffet seems to think United Health is a value stock. As you can see, the stock is about half of its initial value. Buffet is in this for the long term and is hoping that his research is correct in terms of UnitedHealth potentially doubling back up to its previous value faster than the market as a whole would double. Either that, or he hopes his clout is enough to make it a value stock in that more people will invest just because he did.
Holy cow done
That about wraps up the difference between these two types of stocks. Many stocks are a blend of the two, also. But seeing the extremes helps with understanding this way to differentiate stocks. Yes, there are more specifics that I didn't fully get into. And yes I am trying to be as approachable as possible with the topic. Hopefully this helped you!
Can you find an example of a potential value stock out in the world currently? How about a potential growth stock?
For people who don't think they have an edge over professional investors, I propose a third thing: the index fund, where you put most of the money and let it follow the market as a whole, which makes your retirement investments as secure as the market as a whole. And then your investment in value or growth stocks can be smaller bets for the dopamine rather than having our ability to retire be based on your ability to outdo professionals at their own game. I'm not going to say that some people didn't have the right information to buy or sell ahead of the crowd, but for every buyer there's a seller. You've got to be very good to be consistently on the right side of that trade, and most people aren't.
The context of this post is that some are interested in learning about investing (other than the standard good advice of sticking the vast majority in an ETF). See this post.
What you say is of course true, and it is wise for the vast majority of your investments to be in a well diversified ETF, this is for those who are interested in learning about other aspects.
The other aspect re: can’t out perform professional traders- you can’t if you try to do their job and trade over multiple big assets in multiple industries you know little about. As an individual investor your edge comes from investing in things your unique life experience gives you a strong signal is going to cause a change in an industry you know well and ignoring the rest (unlike the professional investor, you can choose not to play if there are no good moves).
Hey people can do what they please with their money but I feel very very very strongly against this mentality. It sounds good on paper, but if the people who have millions/billions at stake, who do this sort of thing for a living, every single day, who have mountains of data and every available analysis tool and prediction model at their disposal still can't consistently beat the market, then I sure as shit am not going to either, regardless of whether I spend a few hours each day/week/month researching some stocks.
Individual investors categorically do not have any sort of edge over the people who do this sort of thing for a living, who have way more skin in the game, and who have been doing this for decades. Sure there is always a chance that you could beat the market. But for every success story you see or read about, there are countless failed gambles that did not pay off. No one (except /r/wallstreetbets weirdos) shares 'hey look I just lost $100k by taking a chance on this random stock" yet a lot of people share their success stories when things go right.
TL;DR: if you are new to investing please do yourself a favor and listen to what @MimicSquid said about index funds. If you want to try beating the market, do so with a small percentage of your total investments to test the waters first before diving in and potentially losing a lot of money.
Thank you and Mimic for reminding us all that index funds are the best place to park the majority of your money!
Again, though, this post is in the context of the investment club, where people specifically mentioned using their side cash/fun money.
Most people wanted to learn more. Hence, this post. And the many others that will follow :)
I agree with you- it’s wise for the vast majority of your investments to be in well diversified ETFs. I am way too risk averse to do anything but that. But I don’t agree there are no situations where an individual can’t have an edge.
There is a caveat to what I’ve said: on average, you can’t mathematically beat the market- that’s the nature of the market. While the market itself is not zero sum, beating the market average sure is. That includes actively managed funds- ie professional investors on average don’t beat the market either. If you try play the markets in general as an individual investor you will most likely lose.
The difference (imo) is when you stick to just situations where you can make wise decisions, have a comparative advantage, and not get drawn into situations where you get greedy and over confident and most often lose money. Leave the greed to the professionals who have to play the game.
For example, If you are a domain expert in x, and you can see how new device/invention y will change the industry, you have a signal others don’t.
These points where you have a specific unique life experience (I use that term to avoid just referring to peoples jobs) are the situations where you can have an advantage over generic investors. These situations are few and far between, and it’s a lot easier if you know how to assess the companies you might want to invest in. For me, learning how to assess companies and stocks for future use in these rare cases is mostly what I’m looking at gaining. I don’t think I can financially assess companies better than professionals, but when I think I do have an edge I want to be able to assess the company to a basic degree at least.
I mean, an extreme take on your view is that you can never as an individual (even if your area of expertise) make a difference to the world or do better than average, as the large companies who have more data will always know more and do better than you. I don’t buy that, in particular rare situations within my chosen domains at a time of my choosing, I reckon I do know better than the rest of the world at large.
But I’m not a professional, and you do what you think is right and you are comfortable doing. For me, when I’m confident in my opinion, I’ll put some money where my mouth is. I enjoy it, and if I’m wrong, I’m only going to lose a small amount, and learn from my mistake.
I’m not sure how well this makes sense, I’ve written this on less sleep than I would like, so please interpret what I am saying charitably!
That's generally the best idea for long-term investment, but even many avid ETF-only investors have like 5% of their portfolio in individual stocks, just because it can be much more fun and engaging that way
Agree 100%, but I will add that even with index funds there are a ton of options/variety. So this post can still apply to people looking to do their own research, but instead of individual stocks they could be debating between growth index funds or value index funds.
For example (in case anyone out there is brand new to this), you could invest in something like VOO which is a fund that tries to closely match the SP500 index (hence why it's called an index fund). Or you could go with VOOV or VOOG which are nearly the same as VOO but have a higher emphasis on stocks in the SP500 that are more value or growth oriented, respectively. So if you like value or growth specifically, you don't have to pick just one company you think will be good, you can go with an index of value/growth companies.
Total market international is usually what I look for. Sure, I won't beat the market, but I can't lose either!
To expand on value investing, the idea is that you calculate what a company is worth based on fundamentals like what assets and debts it has and how profitable it is now. This process is called "fundamental analysis" and the result is called the "intrinsic value." Only then do you see if the stock price is lower than expected. This is a way to try to identify bargain prices.
There will still be subjective judgement calls, but not as much as if you're also taking into account how much the company might grow in the future.
For many stocks (particularly technology stocks), the stock market is a lot more future-oriented - people are trying to guess what a company will be worth many years in the future and pricing it based on that. The prices on these stocks will look way too high to anyone doing fundamental analysis. No bargains there!
True bargains are harder to find these days because investing in value stocks is a well-known approach. A stock that looks like a bargain according to fundamental analysis is one that the stock market thinks has something wrong with it. You need to figure out why and then decide whether you still disagree about the price.
If you're not looking at the financial statements, understanding the business, and figuring out what the company should be worth (or relying on the opinions of people who do that) then you're not doing fundamental analysis. Most amateur investors aren't that interested in doing this homework. It's something I've always been too lazy to do myself.
The Amazon graph is interesting. The outcome that online ordering would likely increase in a lock down/pandemic situation was fairly obvious in hindsight at least, but the share price took some time to take off. I wonder if this attenuated by concerns over supply chains crumbling around that time as well?
Yes, it's very interesting! You can obviously write an entire novel about this if you wanted to do the research, but here's some quick analysis on my end of some things to consider.
The S&P 500 started crashing Feb 20. It bottomed out on Mar 23 (-34%). That's over a month of people not sure what's going on and selling for whatever reasons they had. The overall market returned back to its Feb 19 high on Aug 18.
March 6 there was a spending package passed by the US. Then another higher one on March 18. As you can see, people kept selling and selling! California issued lockdown orders on March 19. Finally, the CARES ACT was passed March 27, after being introduced earlier.
Amazon stock also started crashing Feb 20. It bottomed out on Mar 12 (-23%), and returned to it Feb 19 high on April 13.
Definitely slid less and recovered much faster than the overall market. It's entirely possible supply chain concerns fed into that decline! That and just wondering if people would have jobs and have money to actually buy anything! I've not done the total research. Remember too, people were panic selling all over, even if, as you can see, some people realized quicker than others that Amazon stock would most likely be just fine. Those people stayed calm in the face of fear and trusted their research/knowledge.
There was downward pressure on Amazon stock because of the overall economy concerns, supply chains, having people being able to work in warehouses/delivery and all that.
There was upward pressure due to MASSIVE global stimulus and realization that lockdowns were going to spread, but people were going to have money to spend and need to spend it somewhere! However, that upward pressure took time to develop as you noticed.
Eventually, the demand outstripped the supply and the stock started going up!
So yes, a little mix of growth/value type stock in the beginning, but I would categorize it as much more growth than value overall. People were expecting outsized revenue growth for Amazon. Amazon reported 2019Q4 earnings on Jan 30, 2020. Then reported 2020Q1 (Jan-Mar) earnings on Apr 30, which was decent, but at least not a total loss. Then finally reported 2020Q2 earnings on July 30. That Q2 earnings was massive, and continued to be massive for quite a while.
We didn't have the exact information for Amazon's earnings by the time the stock turned around. People expected Amazon to do extremely well during COVID and lockdowns, and they did. Same with Zoom and others. Zoom took a while because people didn't know just exactly how well it would do. But then Microsoft came in to crap on Zoom's bed.
However, back to Amazon. It's possible somebody panic sold at the top and bought back in a month later knowing that Amazon stock would go back up up up! That's called luck. Seriously.
Timing the market and is basically impossible to depend upon. So don't try it!
I've sold stocks that have gone on to continue growing faster than what I reinvested in. Oh well!
I've also bought stocks that I thought were done falling, but continued to fall before catching back up to where I expected them to go.
Yes, if I had perfectly timed the market, I would have been better off. However, nobody can. You can try to learn about why so you can make better informed decisions in the future, but there is sometimes no reason at all.
Sorry, this whole thing is turning into its own post!
Thanks shadow, what a great start to hopefully a long series :)
In the vein of how field guides approach mushroom foraging, I would like to offer / request additional thoughts on "look-alikes": kinds of stocks that may have some resemblance to Value or Growth stocks, but aren't as tasty or even poisonous.
Falling knife: which Shadow mentioned. These will not recover as quickly as the growth from your long term investments in the overall market or your cash funds. Worst case: they don't have a handle on the crisis and will not recover at all. You want to find good technical indicators they'll make a (out performing overall market) recovery and see confirmation of it happening first. Remember that markets are a human group thing: you won't make as much money as magically guessing the bottom, by waiting till it's clear that enough people have got the handle, but it's okay because you don't want to be buying in too early and seeing the slight up that's actually a ----
Dead Cat Bounce : if a dead cat falls fast and hard enough, it'll bounce / show upward movement when it hits something, but that might not be the floor yet and anyway the cat is still dead.
As for the assigned homework of spotting a potential value / growth, I don't know enough yet on how to actually analyze the numbers. For example, Costco's fundamental business hasn't changed, they're still a wholesale/retail consumer favourite, still making money, still hiring and expanding new locations, but maybe because it's not a sexy tech stock, their one year return is lagging behind S&P500. COST's five year return is 208.36% vs S&P's 96.61% though. Million dollar question: could it not only catch up but overtake overall market?
Thanks for the dead cat bounce!
And that's a wonderful example of a potential growth stock, thank you for your contribution!
As you noticed, the recent growth of Costco's stock has been slower than the overall market. Perhaps it's a blend of value and growth now?
Growth potentially because it still has that history of growing revenue by leaps and bounds every year and is expected to continue, but a little value now too because people were selling stocks in fear of tariffs biting Costco's bottom line?
This is where anybody with an inkling about Costco would have to do more research. As mentioned, to find actual value or growth stocks takes lots of time and energy. Are tariffs not a huge deal? If research leads you to believe that tariffs are the reason for slower stock growth and those fears are generally unfounded because Costco will keep right on growing as a company, then it sounds like that stock would be a good buy!
I plan to do posts about an overview of fundamental analysis, then more posts about specific aspects of that analysis, using Yahoo Finance to look up a stock and compare to others, using stock screeners, understanding the terms on those screeners, actually buying and selling, market/limit orders, entry/exit points, diversification, short term vs long term and tax consequences in the US, short selling, options, all kinds of stuff! And anybody is welcome to make their own posts as well!
After all of this, hopefully everybody will be a pro at being able to actually analyze the numbers for the homework :) and anybody who wants can have a little side-money fun!
Not that every pick will be a winner, but overall hopefully it's a good experience.
I wonder how tariffs affect them? Possibly, gloom due to tariffs might result in getting a better price for a fundamentally sound company. Or not, I haven't researched.
I know right?? It's tarrifs and they'll get over it right? But --
I didn't research cuz I don't really know how, but I'm itching to throw $100 at, possibly only because I like Costco. Which is very bad discipline, because I said to myself this club is for doing homework and then investing, not gambling and certainly not a Wall Street Bet. And anyway even if Costco might be a safe long term hold, it may or may not be Growth (ie, beat market avg), so, being disciplined means I should be content with possibly holding some COST indirectly via ETFs.