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Value vs. Growth--Which Camp Are You In?
The professional stock pickers on Wall Street specialize in a lot of ways. Some focus on small-cap stocks. Some only look at foreign shares. And there's another way they tend to specialize: They're either value investors or growth investors. A growth investor is willing to pay premium prices for companies with above-average growth in sales and earnings. In contrast, the value investor wants to go to the discount rack and buy cheap stocks that are out of favor or are being ignored by Wall Street. Sometimes, growth stocks as a whole outperform value stocks. And vice versa. Growth stocks tend to do well when overall economic growth is sluggish. For example, let's say the U.S. economy grows only an average of 2% in the years 1998-2000. Investors saw that as a distinct possibility in early 1998, as the Asian financial crisis threatened to choke off the growth of the global economy. What stocks shined? Drug stocks, for one. Why? They're able to grow consistently at a greater rate than the overall U.S. economy. Their profits are likely to grow faster than those of the average U.S. company, too. The reason they've been growing so well is that they've got lots of new products in the pipeline. In addition, the Food & Drug Administration, which had long been a sluggish bureaucracy when it came to approving new therapies, has been streamlined and is acting more quickly. Because drug companies promised double-digit profit growth in a singledigit world, investors have been willing to pay more than 30 times earnings for many of these stocks. But even growth managers aren't willing to overpay for the privilege of higher sales and earnings. In mid-1997, Coca-Cola was selling at nearly 40 times earnings, yet its profits were not projected to grow more than 20%. The stock was hovering around $70 a share when the company announced that earnings were going to be disappointing. The stock tumbled to $55 within a few weeks. Indeed, many growth managers temper their enthusiasm for a stock by describing their style as "growth, but at a reasonable price." The value investors on Wall Street believe that it's better to find a stock down on its luck and buy it at a discount--as long as there is a potential catalyst on the horizon to push up the stock price. The classic value stock of the mid-1990s was IBM, which was selling at about 10 times earnings for a few years. The stock was cheap, and for good reason: The company had staked its future on huge mainframe computers, but the world was moving toward the PC, which was becoming increasingly powerful. Value investors in IBM believed that the company had the strength to reposition itself into PCs as well as to move into technology consulting for large corporations. A new chief executive officer was brought in as the catalyst, and he achieved exactly that. Growth and value investors are each quite passionate about their craft. But you don't have to take sides. Both styles have their place in a diversified portfolio.