Hi Pals, if you are new here, so just
let me introduce you to “The Finance Magic” which is all about spreading financial
knowledge. If you are new to the world of finance, then this is a place where
you could rely without any doubt. So before moving on lets first understand a
little bit about valuation and what type of an investor are you?
Do you like to buy cheap stuff right or do you like to buy expensive stuff?
I'll cover that right now quickly, let's kick it off by talking briefly about General Electric and Tesla two radically different companies because General Electric stock is very cheap compared to Tesla which is very expensive. However, Tesla is growing at a much faster rate than General Electric.
So, in most cases you either like to buy companies on the right side of the spectrum, meaning expensive stocks that are growing quickly or cheap stocks on the left side of the spectrum, meaning companies that are not growing quickly but the valuations are more attractive of the companies which are growing quickly?
So, we call investors on the left side of this spectrum as “Value investors” and the high investors that like growth stuff are called “Growth investors” on the other end.
On the other side of the spectrum we have got growth investors, they like to buy stuff that are expensive but growing very quickly and the reason it's expensive is because those companies are focused on growing revenue as fast as possible and they're not worrying about profitability yet until some point in the future. For example: Amazon Inc.
Eventually that stock and all growth
stocks become value stocks. A great example of this is Microsoft. You know
Microsoft is a Wall Street darling, and then growth slowed a lot and growth
investors didn't want to buy it and so for 10 to 20 years it had to transition
from a growth stock to a value stock and now value investors like it. Same
thing with Tesla, it is a growth stock now but one day it will be a value stock
So, let's talk about Value Investors and Growth Investors in a bit more detail:
So, value investors again like cheap stocks that aren't really growing. Growth Investors love stocks that are growing quickly. And value investors love looking at companies on a price to earnings basis meaning, how many dollars you're going to pay for every $1 in earnings and Growth Investors also like looking at price to earnings, that is the price to earnings ratio but they like to invest in companies that have higher price to earnings ratio which means that are growing fast. And so, what they do is they take the “P/E divide by growth” that's called the PEG ratio. And they like to buy companies that are growing at a relatively low PEG ratio and I'll explain this in more detail very soon.
Growth Investors like cash flow a little bit but they want the company to grow faster. They are one, that will be saving money today i.e. just grow.
Value investors love companies that are cheap on a DCF basis (discounted cash flow) and don’t worry we will cover that in our next post very soon. Basically, they want to understand how much cash that company can make today and value investors also like high dividend yielding companies as well. But growth investors don't like using discounted cash flow. They evaluate using vision methodology, they like to look at price to revenue. And the reason they like to look at the price divide by revenue is because a lot of times companies that are investing don't have earnings yet, as they are in their initial phase.
Again, value investors love to buy companies based on Discounted Cashflow basis. Both growth and value investors love valuing companies on an earnings basis and only growth investors like to buy companies on a price to revenue basis. Now DCF is a little bit complicated, I'm not a big fan of it at all but it's about discounting your cash in the future and as said by investors “Cash is King”
And as I mentioned before we look at PEG ratios or Price earnings to growth mainly for growth investors and price to revenue mainly for Growth investors as well because they like investing in companies that aren't too profitable yet but they're growing really fast. And everybody is either a growth investor or a value investor and you might not know what you are at this point of time.
When I was an undergraduate, I was a value investor because I was a little bit more theoretical and I didn't have much work experience as to what it actually is. And I thought, well you got to buy stuff that's cheap. Well now I'm a little bit different.
I don't want to bias you with my outlook here I want to kind of give you a menu of every type of investment you can make. But if your company is growing fast, I don't think you should be making a lot of money yet.
I'll give you an example let's just say Amazon is growing earnings at 100 percent year over year. They can give you that money or they can invest and grow faster and then give you more money later.
Summary:
|
Value Investors |
Growth Investors |
|
Like cheap stocks with low growth |
Like expensive stock with higher growth |
|
Love to value
companies on P/E ratio |
Love to value companies on PEG ratio |
|
Cash flow is very important |
Cash flow is not the deciding factor |
|
Valuation
method preferred: DCF |
Valuation method preferred: Price to
revenue |
I have tried to cover the topic at a
very basic level, I hope you understood the difference between Growth v/s Value
investors and have also known what type of an investor are you?
Stay tuned for more upcoming concepts
Cheers
The Finance Magic
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