Value Investing vs. Growth Investing

In the mid-1990s, a grocery store chain in Atlanta called Harry's Farmers Market Inc. went public, selling shares to investors with the promise that it was going to revolutionize the grocery industry in much the same way that Home Dept Inc. changed the do-it-yourself business.

Early investors in Home Depot, after it went public in 1981, became millionaires many times over as a result of the company's rapid growth, which has made it one of the 10 largest retailers in the world.

For every 10 Harry's — a company with a lot of promise — there is a Home Depot or a Microsoft Corp. Investors who like to buy stocks in companies where there is a lot of growth potential look for what are called growth stocks, and Home Depot and Microsoft were certainly that in the 1980s and 1990s.

Most growth stocks, however, do not pay dividends to investors. Growth companies are businesses in which revenues or profits are typically increasing at multiples of the rest of the industry. Revenues may be rising by 30 percent every quarter, and profits may be increasing by 25 percent or more, while the industry is seeing growth at half those rates.

The opposite of a growth-oriented investment strategy is one that focuses on buying stocks in companies on the basis of their value. So-called value investing looks at the worth of the stock price compared to quantitative barometers. For example, a value investor may look to purchase stocks that appear cheap on the basis of the price-to-book value.

If a company's P/B value is below that of its competitors, or the overall market, then an investor may consider it to be cheap. A value investor may also look at a stock on the basis of its price-to-earnings ratio. If a stock price of a company is trading at around 10 times its earnings, but the rest of the stock market is trading at around 15 times earnings, that stock may be considered to have value.

The opposite is also true. If the P/B or P/E of a company gets to be higher than that of competitors or the rest of the market, an investor may consider selling that holding.

Other value investors prefer to purchase stocks in companies that pay dividends to their investors.

For the most part, investors who take a growth-oriented strategy to investing are taking a greater risk than value investors. Growth means that a company is expanding, and growing means that there is always a chance of something going wrong. Maybe a retailer is putting its stores in the wrong place.

There is less risk in value investing, in general, because these are companies looking to entice investors with their slow, methodical growth. However, a growth-investing strategy may also pay greater rewards for the investor if the company is successful in growing at a fast rate.

If you're playing the market as part of your overall portfolio strategy, then you need to decide what kind of investing tact — value or growth — is more comfortable for your goals.

If it hasn't become apparent already, I'm more of a value investor. There are companies out there that you can virtually guarantee will provide you a return based on their current valuation. Maybe they're in an industry that is out of favor with the overall market right now. But they're destined to return to higher valuations in the future.

If you're a growth investor, there's nothing wrong with that. However, I do think you need to be ready to bail out of a growth stock at the first sign that the company's growth is slowing.

Harry's was not able to follow up on its growth promise. It never expanded outside of the Atlanta market, and many of its investors lost money. It eventually sold out to a competitor and no longer exists.