An Investment Mix

I can tell when it has been a good grocery shopping expedition. Judi, my wife, comes into the house with bulging shopping bags looking like a victor returning with the spoils of conquest. Recently, she proudly announced she had purchased groceries valued at $68.57 for $27.35—a savings of 63 percent. I almost expected to hear trumpets punctuate the glorious announcement with a sonic exclamation point! She paraded over to hand me the receipt verifying her victorious crusade.

A few weeks earlier, Judi returned from the weekly search for bargains with the goods and a story. The grocery store had advertised four boxes of breakfast cereal for $10. Once Judi got to the store she discovered an instant savings of $3.50 off the purchase of four boxes of cereal which brought the price down to $6.50. Judi had two coupons each worth $1.00 off the purchase of two boxes, so she paid $4.50 for the cereal. When the cashier handed Judi the receipt, she discovered a coupon worth $6.00 for her next shopping trip. It’s almost as if the store paid us $1.50 to eat four boxes of cereal. That’s a great deal!

Value Investing, Growth Investing

Just as Judi is a bargain hunter in the grocery store, so some investment managers look for investment opportunities that are selling at a discount to their intrinsic value. This is called the value approach to investing. Warren Buffett, sometimes referred to as the “Oracle of Omaha,” is probably the most widely known investment manager who follows a value approach to investing. The manager of a “value” mutual fund will look for good companies for which the manager believes the stock is underpriced.

A variety of measurements might be used to evaluate a company’s financials to determine if a stock is a good value or not. One of the most common is the price to earnings ratio (or P/E) where the price of one share of stock is divided by the earnings per share. For example, if a stock sells on the market at $36.25 and in the past year its earnings per share was $2.75, the P/E ratio is 13.18 (36.25 ÷ 2.75). Stated another way, to buy the stock at this price, the investor would pay $13.18 for each dollar of earnings. A stock with a P/E ratio of 13.18 is considered cheaper than a stock with a P/E ratio of 18.18 or 23.18.

In contrast, other fund managers are growth investors. They seek above average growth, so they look for hot companies in sizzling industries. The mid to late 1990s witnessed rapid growth in technology. Investing in companies constructing the information superhighway, for example, provided many investors huge return on investment. A “growth” mutual fund will be searching for companies with a strong product line and revenue and earnings growth rates which increase each quarter. A pure growth investor may pay little attention to the calculations a value investor does in the due diligence process. The growth investor could willingly pay a premium for the prospect of explosive growth which would drive the stock price even higher.

So which investment style—value or growth—has produced the greatest historical returns? This question has been debated for years with persuasive arguments on both sides. Some have tried to play both strategies at once, to buy growth stocks at value prices. Others have tried to interpret general economic trends, to invest in growth companies during boom years and in value companies when things start moving up from the bottom of an economic cycle. These strategies require attentiveness and expertise that lie outside what a typical investor possesses.

Instead of trying to be the expert, an average investor can diversify his or her investments among both value and growth styles. For example, if investing through mutual funds in a retirement account, the investor could have some of the investments in value funds and some in growth funds. Read the mutual fund profile for information on the investment strategy used by the fund manager when considering a mutual fund for a diversified portfolio. The investor could add a blended fund to the mix and rely on the mutual fund manager to create an appropriate blend of value and growth stocks.

Individuals have the primary responsibility for building their own secure financial future, but some don’t know where to begin. A typical investor could start by diversifying investments between value and growth strategies.

Originally published by Pensions & Benefits USA.