A Lesson from “Eigengrau” or Growth and Value Investing

Every day, I receive an email from a site called WordDaily. I love to challenge myself to guess the meaning of the word. Recently, eigengrau was the Word of the Day. I recognized its German origin and the “gray” part but not the entire meaning of the word.

Eigengrau – Noun
The dark gray color seen by the eyes in perfect darkness because of signals from the optic nerves. Website link: Eigengrau

A couple of examples of the word’s use: “Before my eyes could adjust to the dark, all I could see was eigengrau,” and “Henry awoke in the eigengrau of total darkness, so he quickly turned on his lamp.” I suspect each of us has experienced eigengrau without knowing it had a name. Now we do!

Many words in the investing world have special meanings and it can often be a challenge to understand them. Growth and Value Investing are two such concepts.

Growth Investing

In the world of investments, growth investing is a strategy that focuses on investing in companies that are expected to grow at an above-average rate compared to their industry or the broader market. Growth investors aim to buy young, early-stage companies that are seeing rapid growth in profits, revenue, or cash flow.

One such example is industries where new technologies and services are being developed. Tesla, Amazon, and Meta are growth companies. But even older, less tech-savvy companies can be considered growth investments. For example, Home Depot is currently categorized as a growth company. Some growth companies may not have earnings now, but they are expected to in the future.

Understanding the life cycle of companies is key to understanding growth investing. In the early days of a new company, business may grow at a rapid pace and generate impressive gains in revenue and profits. At this stage in its life cycle, a company typically reinvests profits back into the business to drive further growth, rather than paying them out as dividends.

As the company and its markets begin to mature, growth in revenue and profit slows. Once the company is fully mature, growth slows further. At this point in the cycle, many companies begin to distribute profits to investors in the form of dividends as the investment opportunities available in their markets begin to diminish. Growth investors look for profits through capital appreciation, the gains achieved when their stock is sold, as opposed to dividends received while they own it.

Growth investing is attractive to investors because of the potential for returns if the companies are successful. However, such companies are often untried, and thus often pose a higher risk. Market sentiment can send growth company values falling as they did during the dot-com bubble. Growth stocks may trade at higher price/earnings (P/E) or price/book (P/B) ratios.

Growth investing may be contrasted with value investing,

Value Investing

While growth investing seeks out companies that are growing their revenue, profits, or cash flow at a faster-than-average pace, value investing targets older companies priced below their intrinsic or book value.

Value investing doesn’t mean you’re buying a stock that has zero growth. It just means that growth isn’t the main appeal. Instead, you’re investing in a company that is likely to be underpriced and overlooked when compared with its growth rivals. To determine whether a stock is underpriced, market analysts look at a company’s fundamentals (such as dividends, earnings, and sales) relative to its current share price.

Maybe the value stock in question isn’t seeing massive expansion but delivers a predictable stream of earnings and dividends. Or maybe the company has fallen on hard times, creating a bargain opportunity. Or maybe it’s just plain boring, like a publicly traded utility stock or a small and specialized chemical manufacturer, and nobody is even paying attention.

Whatever the case, value investing is usually about finding hidden gems. The appeal isn’t popularity or future growth projections, but rather the current underlying value of the business right now.

General Electric is an example of a value stock. The firm is clearly not in growth mode. Back in 2018, it recorded $97 billion in revenue but more recently around $64 billion. However, GE stock surged more than 70% from January 1 to August 1 of 2023. What investors see in General Electric is its underlying value. One famous value investor is Warren Buffett.

Which Is Better – Growth or Value?

Historically, value investing has outperformed growth investing over the long term. A long-term comparison by Dimension (DFA) from 1927 to 2021, found value stocks annually returned 4.1 percentage points more than growth stocks, on average. More recently, however, growth investing has outperformed value investing. Value and growth stocks move in cycles.

According to Forbes Advisor, “Since 1995, value mutual funds have returned 624%, while growth mutual funds have returned 1,072%. Vanguard index funds show a similar trend. The Vanguard Value Index Fund (VVIAX) has returned on average 6.18% annually since its inception in 2000. In contrast, the Vanguard Growth Index Fund (VIGAX) has returned on average 8.10% annually over the same time.”

While growth stocks have recently been the darling of investors, that trend may be changing. With the rise in interest rates, the cost of capital, which is essential for growth companies, has risen. Some investors, particularly those who are retired, may not have an appetite for growth company risk but instead seek value stocks’ steady income.

According to Schwab, value investing increases the durability of a portfolio. Durability refers to a portfolio’s capacity to avoid the largest drawdowns in price. It’s about reducing portfolio volatility despite greater conditions of volatility across the broader market.

“By holding fundamentally sound stocks that aren’t greatly overpriced, an investor might be able to reduce the level of drawdowns in their portfolio, achieving a relative degree of durability because the most overpriced stocks may draw down at a greater rate than fairly priced or underpriced stocks.”

A Blended Approach

There’s no need to exclusively pursue a growth investing or value investing strategy. A better way could be to take what’s referred to as a blended approach. A blended investing strategy means you buy companies that fall into both value and growth categories. This can be as easy as investing in an S&P 500 index fund.

The returns you can get by pursuing a blended approach typically lag either a growth or value strategy short term, depending on which is outperforming the other. It may be psychologically difficult to stick to a blended approach when more money is being made either with growth or value investing. However, over the long term a blended approach can often outperform an investor who switches between growth and value to try to time the market.

Let’s Have a Conversation:

Do you use a growth approach to investing? Have you tried the value approach? What do you think about each? What other approaches do you use?