Exploring Value Investing: Understanding Its Principles and Differences from Growth Investing

In this article, we will explain what Value Investing is, how value stocks differ from growth stocks and the advantages and drawbacks of this type of investing.

Value investing definition 

Value Investing is a strategy based on identifying and selecting undervalued stocks with the use of technical analysis. Quite often, such stocks include the securities of large companies with a high dividend yield.

There are times when the market reacts to negative events too dramatically, thereby provoking a decline in the stock prices of some companies, which does not comply with the long-term fundamental performance of the said companies. This excessive reaction of market players allows for buying stocks for less than their intrinsic value, i.e., less than they are worth.

The strategy of Value Investing is based on the concept presented in 1920 by two Columbia Business School professors – Benjamin Graham and David Dodd. It was improved in 1934 and later became popular after Graham published his book "The Intelligent Investor" in 1949.

Legendary value investors

• Warren Buffett. Also known as "the Sage" or "the Oracle of Omaha" is the main influential value investor of the modern era, as he is a firm believer in the value-based investing model; Buffet created a financial empire by purchasing undervalued stocks
• Benjamin Graham. He was the patron saint of the Value Investing strategy, as well as an author, founder of an investment organisation, and Buffett's mentor
• Charles Munger, a billionaire investor, and Buffett's right-hand man
• Bill Ackman, Founder and CEO of the Pershing Square Capital Management hedge fund 

Growth vs Value stocks: what is the difference?

Growth stocks are securities of companies with fast-growing revenue and prospects of serious price growth in the future. Such companies invest the maximum in product development and improvement of their market positions and therefore pay little to no dividends. Quite often, they belong to the tech or biopharma sectors.

Value Stocks are securities that investors consider to be trading below the fair market price. Meanwhile, the stockholders usually receive large dividends. Investors prefer using such stocks as hedging options in complicated market conditions, given that they remain stable even in times of crisis. Such stocks usually belong to financial and energy companies.

Growth and value indices

Simple strategies of value or growth investing imply selecting stocks included in special indices – the S&P 500 Pure Value Index and S&P 500 Growth.

S&P 500 Pure Value Index

This value index consists of stocks included in the S&P 500 index and exhibits the best value. The S&P 500 Pure Value Index has been calculated since 2005 and consists of 119 companies.

On 30 November 2022, the Top 5 leading sectors of the index were:

• Financials – 31.1%
• Health Care – 13%
• Energy – 11.2%
• Consumer Staples – 10.2%
• Utilities – 7%

The Top 5 companies of the index are:

• Marathon Petroleum Corp. (NYSE: MPC) – Energy
• Cigna Corporation (NYSE: CI) – Health Care
• Berkshire Hathaway Inc. (NYSE: BRK.B) – Financials
• Valero Energy Corporation (NYSE: VLO) – Energy
• Archer-Daniels-Midland Company (NYSE: ADM) – Consumer Staples

S&P 500 Growth

This growth index consists of company stocks that represent the growing sector of the stock market. The index has been calculated since 1995 and comprises 242 companies.

On 30 November 2022, the Top 5 leading sectors of the index were:

• Information Technology – 44.1%
• Consumer Discretionary – 14.8%
• Health Care – 12.9%
• Communication Services – 9.8%
• Financials – 7.6%

The Top 5 companies of the S&P 500 Growth index:

• Apple Inc. (NASDAQ: AAPL) – Information Technology
• Microsoft Corporation (NASDAQ: MSFT) – Information Technology
• Amazon.com Inc. (NASDAQ: AMZN) – Consumer Discretionary
• Alphabet Inc. (NASDAQ: GOOGL) – Communication Services
• Tesla Inc. (NASDAQ: TSLA) – Consumer Discretionary

Value investing ETF

Value ETFs are exchange funds that analyse the Price/Earnings Multiple, Price/Book Value Ratio, etc. to identify undervalued stocks and invest in them.

Popular Value ETFs:

• iShares MSCI USA Value Factor ETF (VLUE)
• Vanguard Russell 1000 Value Index Fund ETF (VONV)
• Invesco S&P 500 Revenue ETF (RWL)

Advantages and drawbacks of value investing

Advantages:

• Value stocks are the securities of large and strong companies that are established in the market
• As a rule, their stockholders receive good dividends
• Such stocks are less prone to price fluctuations, thus being more stable than growth stocks during market crashes
• Value stocks have growth prospects thanks to the good fundamental performance of the company

Drawbacks:

• Risk of capital losses
• Detailed fundamental analysis requires a lot of time
• Any fundamental analysis is subjective

Summary

Value stocks are securities that investors consider to be trading below their fair market price. Investing in them is called value investing. Most often, these company stocks belong to the financial or energy sector.

Investing in value stocks has both drawbacks and advantages. Among the advantages, there are the prospects of stock price growth and dividends, while the drawbacks include high risks of losing your capital.

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