retrorocket/istock
Do you really know who you are when it comes to investing? Many people don’t, and sometimes they never learn. That can lead to mismatched portfolios, unnecessary risk and weak performance.
At some point, every investor comes face-to-face with a basic decision: Am I a value or growth investor? The answer should reflect your personality and guide your buy/sell decisions.
Value investors buy stocks that are trading at a discount to their true underlying worth, or intrinsic value, because they believe the market has overreacted to good or bad news and mispriced the stock. By conducting fundamental analysis of financial statements, they identify undervalued companies with solid fundamentals and hold them, anticipating that the market will eventually recognize the company’s actual worth. In other words, value investors seek to buy low, sell high. Warren Buffett is the most recognizable value investor practising today.
Value stocks usually display these characteristics:
- Low valuation: Their p/e ratios will be below the market average, sometimes by a lot.
- High dividend: Value stocks tend to offer above-average dividend yields.
- Corporate maturity: These are not fast-growing businesses. Those years are behind them.
- Stable earnings: These are profitable businesses with slow but predictable growth.
Typical value stocks include banks, insurance companies, conglomerates, utilities, industrials and REITs.
Should I move out of this apartment REIT, or stay put?
Growth investors are a different breed. Their goal is to profit from the capital appreciation of stocks by investing in companies with a high potential for earnings and revenue growth that is expected to outpace the overall market. These companies typically reinvest their profits back into the business to fund expansion rather than paying dividends. Growth investors expect their share prices will rise substantially as the companies achieve their growth potential.
The main characteristics of growth stocks are:
- Rapid revenue growth: Nothing excites growth investors more than seeing a company’s revenue grow by 30 per cent or more year after year. Interestingly, profitability is not as much a concern. The expectation is that a rapid increase in revenue will eventually show up on the bottom line.
- High valuations: The p/e ratios of growth stocks tend to be on the high side, sometimes absurdly so. Or there may be no p/e at all, because there are no earnings.
- Low or no dividends: Growth companies prefer to reinvest in the business rather than pay dividends to shareholders.
Technology stocks are far and away the leading sector when it comes to selecting growth securities. These include companies involved with artificial intelligence, semiconductors, software and cloud computing. Another popular sector is health care.
Cathie Wood, founder of ARK Invest, is one of the top growth investors in business today.
So, which is the most rewarding over the long term, value or growth? This may come as a surprise, but in terms of the TSX, the winner is value.
I compared the performance of the iShares Canadian Value Index ETF XCV-T with that of the iShares Canadian Growth Index ETF XCG-T. Both have the same MER of 0.55 per cent. Both were launched on Nov. 6, 2006, so we have 19 years of data with which to work. No matter what time frame we look at, value investors are doing better.
Opinion: Value stocks are not the underperformers you’ve been told they are
Since inception, the value ETF shows an average annual compound rate of return of 8.28 per cent (to Sept. 30). The growth fund has averaged 7.56 per cent a year. The five-year average annual compound rate of return for XCG is 12.01 per cent, while XCV has gained 21.37 per cent. Year-to-date, as of Oct. 16, the value fund has added 24.93 per cent while the growth fund sits at 17.64 per cent.
Value fund investors are also receiving more money in distributions. Over the past 12 months, XCV has paid out quarterly distributions totalling $1.46 per unit. XCG distributed just over $0.28 in the same period.
Looking at their portfolios, XCV focuses on the big banks (RBC is the largest single holding) and energy stocks like Suncor Energy Inc. XCG favours tech companies such as Shopify Inc. and Constellation Software Inc., railroads and gold miners.
Now here is the kicker. The growth fund has $142-million in assets under management (AUM). The value fund has $91.8-million, or about one-third less. Clearly, we’re stuck on the idea that growth means more profits. That’s not the case with the TSX. Perhaps it’s time to shift gears.
We’re adding XCV to our Internet Wealth Builder recommended list. The units closed Friday at $47.35.
One final point. This analysis is based on the TSX. The U.S. market is a different story. Apart from Shopify, Canada does not have any of the high-flying tech stocks that dominate the Nasdaq and make up about one-third of the market cap of the S&P 500. They have propelled the U.S. equivalent of XCG to an average annual gain of 8.57 per cent since its launch in May, 2000, compared to an average annual return of 7.31 per cent for its value-based equivalent.
Gordon Pape is editor and publisher of the Internet Wealth Builder and Income Investor newsletters.