One hallmark of genius is the ability to see through conventional wisdom; to “think different,” to borrow Apple’s old slogan. Billionaire Warren Buffett is a financial genius, as proven by his contrarian views on some widely held investment strategies and attitudes.
One place where Buffett parts ways with the pack is the supposed difference between “growth” investing versus “value” investing. Financial pros have traditionally viewed these as separate and incompatible strategies. Buffett thinks that distinction is crazy. His thoughts on the issue are worth hearing, whether you’re an active investor, buying and selling stocks in your portfolio, or just want to better understand how the assets in your 401k investments are being managed.
First Things First: First, some definitions. Growth stocks are shares in companies that are investing all their resources in expansion with an eye towards dominating their particular market. Current high-visibility growth stocks include Netflix and Amazon. Investors buy these stocks with the expectation they will steadily increase in price and net a tidy profit when sold.
Value investors go hunting for shares they believe are undervalued by the market but still have a strong potential upside. This is done by analyzing a company’s intrinsic value and comparing it to its current market value. Intrinsic value is assessed by analyzing the company’s fundamentals – its business model, competitive situation, management quality, and the state of its financial statements. If the company’s intrinsic value is higher than the current market value, its stock is deemed a value.
Those who believe in value investing often look to profit off the market’s occasional irrationality, particularly its tendency to overreact to certain types of corporate news, including the release of quarterly reports. For example, earlier this year, Fit Bit released a quarterly report that showed a 50% year-to-year increase in revenues and a prediction of continued revenue growth in 2016. However, because the company had invested heavily in R&D, earnings per share dropped on a year-to-year basis. The result: a 19% drop in Fit Bit’s stock price, which created the perfect opportunity for value investors to buy a strong stock at a significant discount.
What Would Warren Do: Buffett believes that value investing – acquiring under-valued assets -- is the only true form of investing. Buying stocks that trade above their intrinsic value, he says, is little more than speculation. However, Buffett dismisses the church/state separation between growth and value approaches to investing, calling it “fuzzy thinking.”
Growth, Buffett explains, is just one component to be examined in assessing a company’s intrinsic value. While growth is usually positive, it can be negative if that growth is bought at the cost of a heavy investment in a new product line or geographic expansion that ultimately fails. Instead of “simplistically” labeling a stock “growth” or “value,” investors should take a holistic view of investments, considering every aspect of the opportunity.
Buffett’s thinking is illustrated by his recent $1 billion investment in Apple. Shares in the world’s largest company have dropped this year based on market fears that Apple won’t match 2015’s stunning growth in 2016, and that it may be losing its competitive edge. Buffett does not share that view and instead sees Apple’s current doldrums as a temporary situation.
While we won't suggest you just copy all of Buffett's investment decisions, we do believe that value investing can be a powerful approach to your portfolio. Next time you're looking to rebalance your portfolio, you might ask yourself if Warren Buffett would consider the stocks you pick a "value" investment.
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Disclosure: This information is provided to you as a resource for informational purposes only. It is being presented without consideration of the investment objectives, risk tolerance or financial circumstances of any specific investor and might not be suitable for all investors. Past performance is not indicative of future results. Investing involves risk including the possible loss of principal. This information is not intended to, and should not, form a primary basis for any investment decision that you may make. Always consult your own legal, tax or investment advisor before making any investment/tax/estate/financial planning considerations or decisions.