Value and Growth
Value and growth – written Feb 2022
There’s been lot’s of discussion lately in the sharemarket about value and growth so what do these terms mean and how do they affect share investors?
Value shares have a relatively low price in relation to earnings – that is, they have a relatively low PE ratio. They almost always have sound fundamentals. Fundamental analysis is discussed in greater detail in my books but basically a company with sound fundamentals produces a well- accepted product (or products) with a good market share and a history of earnings and usually worthwhile dividends. Some examples include the major banks, retailers, miners, investment companies and property trusts. These shares are also known as ‘defensives’ and are considered relatively low risk.
Growth shares have a relatively high price in relation to earnings – that is, they have a relatively high PE ratio. They are also known as ‘speculative’ shares. They’ve been issued by a company in order to raise the capital required to embark on some new venture they believe will be profitable. The company usually doesn’t make a profit at the present time (or only a small profit in relation to price) so the share price is based on ‘blue sky potential’. The share price is often quite low and may be in cents rather than dollars. Examples include small exploration companies, developers of new software, medicinal products or other products that so far don’t have an established, profitable market. These shares are relatively high risk because if the venture doesn’t prove to be successful before the money runs out, the company may have to liquidate and their shares become virtually worthless.
Effect of inflation and interest rates
Usually in times of low inflation and low interest rates, growth shares can be a better proposition for investors than their more sedate cousins – value shares. This is basically because at such times money is cheap so speculative ventures can more readily obtain the capital they need to continue operating and developing their products without facing a large interest bill. This gives them time to develop and market their products before running out of funds. This is an over-simplification but is essentially the underlying reason.
Over the last decade or so, we have had a period of low inflation and low interest rates worldwide, and especially in Australia, so growth shares have often proved to be more profitable for investors than value shares. The beauty of these shares for investors is that a low priced share needs only a relatively small increase in its share price to become a very profitable investment. For example if a share is trading at say 10¢ and the price rises by only 10¢ in a year or so, the investor gets a return of 100% on their investment. On the other hand if you consider a value share such as the Commonwealth Bank trading at around $100 it’s difficult to see the price rising by $100 to $200 in one year.
But the winds of change are stirring the trees and there’s every indication that the period of record low inflation and interest rates may be coming to an end. As I write, the US is experiencing a big increase in inflation and in Australia inflation is also on the march (although at a lower rate). Although the Reserve Bank is promising to maintain low interest rates for some time, if inflation keeps increasing it’s very doubtful how long they’ll be able to hold out.
In summary – it’s highly likely that in 2022, value stocks will be more sought after by investors and growth stocks could be in decline. I suggest it would be prudent to adopt the strategy I outline in my books; that is, have most of your investment capital in ‘core shares ‘ consisting of value shares and only a relatively small amount in ‘satellites’ which are the growth shares.