Growth vs. value: A matter of style

Investing is a matter of style, and I don't mean what you wear to your broker's office.

Investment style refers to management style — what type of stocks you buy or what type of stocks a mutual fund buys.

There are several investment styles, such as favoring small-company stocks over large-company stocks. But investors' overriding styles are those that go for growth and those that prefer value.

Growth stocks are ones that investors and professional money managers believe will increase sales and earnings at a rate faster than the market or industry average. Investors believe the stock's momentum is moving upward at a pretty good clip.

The "new economy" stocks — those issued by high-tech, telecommunications and Internet companies — are recent prime examples of growth stocks. Growth stocks tend to sell at fairly steep prices in relation to their earnings, and they typically are more volatile than value stocks.

In the lexicon of the fashion clothing industry, growth stocks might be considered the hot, trendy styles of today — the ones displayed on runways and in store windows. They're the ones everyone's after.

Value stocks are those that are out of favor but that some investors believe will bounce back in the future. Before this year, few investors and analysts were paying attention to these stocks. They may belong to an entire industry that is not doing well, or a company whose price dropped dramatically following an announcement that earnings fell short of analysts' expectations. Thus, a growth stock can quickly become a value stock.

Value investors or mutual fund managers rummage for stocks with fundamentals and long-term prospects that appear excellent, but which are undervalued in relation to the company's "intrinsic" or "fair market value."

Like growth investors, value investors believe their stocks will grow in the future (and, they hope, become a growth stock). They just aren't willing to pay a high price for them. Value investors are patient. It might take years before the stocks provide major gains. Warren Buffett is the consummate value investor.

Because value stocks are priced so low, they typically are less volatile than growth stocks — only 75 percent as volatile according to a study by discount broker Charles Schwab & Co. Inc.

Again, in the fashion vernacular, value stocks tend to be the more traditional styles, well-made but not trendy at the moment. Shoppers find them on the bargain racks in the back of the store.

Investors in growth and value stocks further accessorize these styles with other styles. They might buy small-company value stocks or big-company growth stocks. You can find mutual funds that specialize in virtually any style combination, including funds that "blend" styles.

A mutual fund should make it clear in its prospectus which style it pursues. Generally, individual growth stocks have earnings growth that significantly exceeds the earnings growth of the broader market. For value stocks, earnings growth typically trails the market, and the price of the company's stock is usually below its intrinsic or fair market value.

However, there is no single method for differentiating growth vs. value. It may be a combination of criteria, or one criterion may be more appropriate than another criterion for a particular type of company.

Another critical point to keep in mind about growth vs. value stocks is that these overall styles tend to ebb and flow. Growth was in fashion the last several years, but now value stocks are coming back into vogue, as they were earlier in the 1990s. That's why Dennis Filangeri, a San Diego-based certified financial planner, recommends that you diversify by owning both investment styles. Of course, as with clothing, you may prefer one style to another, or one style may be more suitable for your current investment needs.

Just keep in mind that what is in fashion today may not be in fashion tomorrow, so you may want to have some of both styles hanging in your closet.

Zall, Bureaucratus columnist and a retired federal employee, is a freelance writer based in Silver Spring, Md. He specializes in taxes, investing, business and government workplace issues. He is a certified internal auditor and a registered investment adviser. He can be reached at miltzall@starpower.net.