Value vs Growth - Why is there even a debate

Does anyone else see the issues of comparing Value and Growth as two different practices? Why are we even debating this?

If quality investing was this easy, everyone would be a winner by choosing one or the other, but even then, I'd have no faith in an efficient market, because given time, there would most likely be a cult-like following for either the 'Growth' or 'Value'. Cults create group thinking and herds, and these biases drive capital flows and in some cases can also destroy capital. If our starting ambitions are to grow and preserve capital, I think the processing of information through either the growth or value lens has already derailed this intention.

Here's the reality of investing real tangible capital into ideas that are flawed. Those who believe investing is either value or growth add no meaningful insight into a singular investment or whether an investment manager's risk or return profile is good or bad. It's exactly this type of boundary that creates fragility in allocating capital whilst increasing risk for free, not minimising it.

The 'Dot Com' bubble in 2000 proved this notion well. Technology companies were classified as the 'Growth' stocks of the future and were supposed to grow rapidly and with it came very high ratios. Capital flowed and institutions encouraged more and more capital into the market.

There was a lot of euphoria, and the tech stocks were highly overvalued, and we saw enormous corrections once the bubble burst. If we bring investing to our recent past, say the last 10-15 years, we saw companies such as Microsoft, Google and Amazon seem 'expensive', a similar notion that was applied in the 'Dot Com' era, but in fact, these companies were undervalued in relation to their cash flows. So I ask the question, were these Value stocks or Growth stocks? should they even need framing? Ultimately, these are businesses with earnings and we should be looking to assess whether the multiples justify the market caps, not framing growth or value.

As investors, we really need to think deeper about the perils of this type of thinking. Do we put this down to behavioural biases? are we anchoring to what we are being sold without independent thought?

This boxed mental framework doesn't mean 'growth' stocks are bad, equally, it doesn't mean they are necessarily good either. It's not about sticking with one tribe over the other, and it certainly isn't a basis to make an investment decision. Quality investing isn't a popularity contest.

If we can reason with the points raised so far, then we soon come to realise that the terms 'Value' and 'Growth' start to lose their meaning. The institutional mirage starts to disappear.

How the Institutions sell the idea of Value and Growth

Institutions are built to sell financial products and tend to dress the words 'Value' and 'Growth' as specific categories of stock that tend to be deeply embedded into the themes they deploy across their marketing efforts. It's shorthand to convey an easy idea which has highly dangerous consequences. It stipulates that growth stocks will naturally have higher earnings than value stocks. 

This simplified classification suggests that value and growth investors are trying to practice two different disciplines that have two different outcomes. However, in reality, all investors would agree on one thing, and that's their end goal is the same, which is to buy something cheaper than what it's worth.

So why is the industry set up the way it is? Why do behavioural biases creep into some institutional offerings? With some common sense thinking, it becomes more transparent that it's skillful marketing than it is the craft of valuation. Here are some points that come to mind.

Isn't all investing 'Value' Investing?

The idea of using 'Value' vs 'Growth' as a framework to decide whether something is worth investing in has never really clicked with my thinking, as much as I've tried to be open-minded and look at this from different angles. Over the years I've come to observe that it's tough to untangle this institutionalised thinking until you are willing to unlearn and learn again from a different lens. For investors to truly succeed over decades we must encourage more independent thought to find that truth.

If we don't search for the truth, it remains a marketing tool, rather than a conversation about what the business is worth, and whether we should invest in it or not. We should be asking whether the company is over or undervalued, not whether growth is better than value, and visa versa.

False Comparison - A Limited Framework

Having a 'Value' vs 'Growth' mindset sees the investor look at businesses through two different sets of eyes. Each of the two anchors the investor to take their biases into each one of the two arguments to validate the reason for investing in the first place. In psychology, they call this 'cognitive dissonance'. This compartmentalised thinking not only confirms a bias, but it penalises a specific company by the simple fact it must fit into either 'Growth' or Value', and it fails to capture the personality of the business, especially when some companies are in industries that are cyclical, some companies have growth that changes from year to year, or some companies that seem overvalued, are in fact cheap.

This oversimplified thinking can mislead investors into making bad investment decisions. Yes, the overall idea is to simplify complexity, but no simpler than it needs to be, I feel that the nuances should be respected.

Focusing on the fundamentals of the company is very important. Every investor needs to work hard on the valuation process as well as qualifying the quality of the business and its potential cash flows. This should take precedence over the irrational style of comparing 'Value' and 'Growth'. 

Digging a Little Deeper - Independent Thinking, Facts and Reasoned Convictions

The value of any listed or private company is simply the present value of any future cash flows. If we can reason with this, we will see that there must be the ability to estimate the size of these cash flows and when they will be generated. This is all discounted at an appropriate rate to uncover a present value.

The 'growth' metrics of a company will determine the cash flows of the business, and in turn, will reveal a 'present value' of what it may be worth. As you can see, growth plays a huge part in discovering value. The business must not only grow linearly, it must grow to create value in the business to capture future cash flows. A company creates value by investing in its business so it can increase the top-line and bottom-line performance, and the return on capital invested should be higher than the overall cost of capital to run the business. It all seems so easy, but why do investors fail time and time again? Rational thought, patience and discipline are key elements, but not many are willing to do what it takes to implement sound judgment, this means lots of independent thinking and taking the path less trodden to evaluate businesses. Not to chase shiny new investments that are the talk of the town. This is why investing is tough.

This leads us nicely to the topic of multiples. Time and time again we see analysts valuing companies using multiples. Such as P/E ratios, P/B ratios, EV/EBITA. These are relative pricing metrics to compare stocks to their sector peers, or in private markets to compare two businesses in the same industry. Valuing a business is a totally different approach. Investors who understand the framework of valuing a business will never justify the worth of an asset based on simple multiples and then comparing it to another business in the same sector. One business may be of a better quality than the other, and its earnings may be more enduring than its competitors, so how can the value of the two be the same based purely on multiples? But it's a great tool for the private and public markets and their investment bankers to bid up businesses. So naturally, as a selling tool, it's great for institutions to compare relative 'Value' and 'Growth' products based on the psychology of two simple words, 'VALUE' and 'GROWTH'.

Final Thoughts

Anyone who gives it time and thinks critically will conclude that growth is a big part of value, and vice versa. Thinking with a clear boundary between the two will only destroy long-term performance. Ultimately, every investor should know what they are buying in the first place. Conviction should be reasoned and this comes with a clear understanding. If we can't justify this, we shouldn't be investing. We are merely speculating by disguising it as investing, and the idea of 'risk management' and the 'preservation of wealth' become arbitrary topics of conversation that make the investor feel that they are on track. In fact, this is where the real fragility lies and it is fraught with risk, and this is why I feel the Value and Growth debate is redundant when it comes to growing and preserving wealth. If the starting point of one's thought process is fraught with risk, the destination will also be tough to reach. 

The 'Value' vs 'Growth' debate takes the investor's mind into a completely different paradigm shift which has nothing to do with the fundamentals of a business or its intrinsic value. The worst part for an investor is that it adds no value to the thesis of the investment and neither does it add any insight into the investor's risk/return profile, as it focuses purely on an artificial boundary that does not exist. It's window dressing and it doesn't make sense.

Investors who want to make a meaningful impact on their capital over the long term need to evolve both their own thinking and the investment philosophies they buy into. Reason with everything, even if an idea is marketed to you every day. Let us be ruthlessly independent in our thinking, we owe it to our capital.

For many years I've been a dedicated student of the works of many successful investors who have come before me, but it's also been an important part of the journey to reason with their learnings in order to form conclusions for myself rather than blindly following the likes of Warren Buffett et al. If you listen carefully to his words and read between the lines, you'll find there is a lot more to unpack than taking his words at face value.

If we take Warren Buffett's investment style many years ago, and then compare it with today, we'll see his evolution. Rather than being fixated on 'Value' vs 'Growth' or fixed formulas and mathematics. Dynamic, open-minded thinking gave him a better idea of the future potential rather than balance sheet items and backwards-looking statistics. The art of successful investing is forward-looking, and this is how Buffett has evolved from looking at 'cigar butt' cheap stocks (so-called value style) to businesses like Coca-Cola and The Washington Post (so-called growth style) that weren't low in valuation terms for Buffett.

For investing to be truly intelligent we need to be both backwards-looking and forward-looking in our analysis. We can't afford to create boundaries in the mind that cause biases in the decision-making process. Buffett used to steer clear of tech stocks, and the herd mentality of the hardcore value investors also stayed away from 'growth' related businesses too. They missed the point that the real value was in its value-adding growth inside real businesses, not the fact that they became 'growth' investors overnight by betraying 'value'. This boxed mentality made many value investors miss the opportunities in the great tech run over the last decade.

Guess what? Buffett ended up buying Apple. He evolved and learned from his old processes and saw growth and value as one with Apple.

Here is the irony, Apple has been one of his most successful investments to date, so it certainly paid to question his own conventional wisdom. This is a big lesson for investors, it's the ability to navigate ego and be self-critical. It nurtures independent thought in order to make the right capital allocation choices that have a sensible starting point. Rarely are their second chances to think well, and the public market is an unforgiving place to find out.

This is why it's super important to be as intellectually honest as we can be in our thinking right from the start.