Whenever we hear or come across the term ‘philosophy,’ we often imagine heavy topics such as the fundamental nature of knowledge, reality, and existence. However, have we ever thought that certain philosophies could also govern the realm of financial investments?
Well, it might sound surprising, but even in finance, investments are often made following a few philosophies. However, these philosophies are different from academic disciplines. Investing philosophies are all about a particular set of beliefs or processes comprising a coherent way of thinking about how markets perform, which heavily influence an investor’s financial behavior. Simply put, an investment philosophy is a set of principles that influence an individual’s decision-making.
While a couple of investment philosophies exist, two prominent ones continue to influence investors’ decisions: Value Investing and Growth Investing.
An investor opting for the value investing philosophy ideally chooses to identify and invest in undervalued companies. Structurally and growth-wise, these companies are somewhat underrated owing to their slow growth. However, they tend to have a strong underlying value. The idea is that the capital markets will eventually end up recognizing the value, resulting in substantial profits.
On the other hand, following the past growth investing philosophy, an investor would ideally choose to invest in companies that are performing slightly better and are expected to grow faster than their counterparts, thereby shelling out more profits.
Identifying Value and Growth Stocks
There are a few ways to identify which investment philosophy will suit you. To identify value investing stocks, one needs to indulge in a detailed comparative analysis of the capital market’s value and the underlying value of the market. The latter is calculated based on certain metrics such as financial statements, business models, and the company’s overall position against the market competition. On the other hand, the primary indicator for identifying growth stocks is consistent above-average growth of a company over a certain period.
Both investment paths have their own merits and demerits.
- Affordable: This particular method is comparatively affordable. Stock prices are low compared to their sales or profit.
- Less-risky: In terms of the risk component, value stocks are less risky. This is because they have proven their ability to generate profit over time.
- Expensive: The growth investing philosophy is comparatively more expensive than its counterpart. This is owing to investors’ expectations regarding returns on investments.
- Risky in nature: Investors’ expectations tend to be higher. And if growth plans do not materialize, stock prices slide down.
When it comes to drawing a comparison between the two and concluding as to which one is better is a rather tricky question. In fact, to date, it continues to be a ‘million-dollar question’ that even experts refrain from commenting on directly. That is because there is no exact straightforward answer to this question. Capital markets are highly influenced by numerous factors, including global ones such as the pandemic (and many more), and volatility is a part of investing. Therefore, coming up with a concrete answer is almost impossible.
However, it can be said that the choice of investment philosophy – value or growth, depends largely upon an investor’s risk appetite and overall objective in terms of financial planning and investments.