Investing 101

A quick guide to value and growth styles

In the 1950s and 1960s, there were very few mutual funds in Canada, and most had broad investment mandates. It was the job of a fund manager to act on behalf of a group of clients and use his or her security selection capabilities to produce a reasonable return. If that return came from owning more bonds than stocks, so be it - that was the manager’s call. Today, as the mutual fund marketplace has expanded and evolved, investors and advisors have required that fund managers be more specific about what they do. Very few investors buy just one fund anymore, so funds are often designed to play a specific role or have particular risk-return characteristics in order to fit into a portfolio of funds and other investments.

Focusing on growth and value

Academic researchers often define value stocks as those with a low ratio of price-to-book value and growth stocks as those with a high price-to-book. (Definition: book value refers to a company’s assets, minus any liabilities and intangible assets, per outstanding share). In addition, growth stocks typically have higher price/earnings (P/E) ratios than value stocks. In other words, value stocks represent a bargain hunter’s approach to investing: buy stocks that are selling cheap relative to their assets with the expectation that eventually other investors will recognize this discrepancy and correct it by pushing the stock price up. Growth investors attempt to identify businesses with the best future earnings prospects and believe that the market will continue to pay a premium for the best growers in the future. There are wide differences among growth managers in the price they are willing to pay for growth.

These are the most basic definitions of growth and value: expensive vs. cheap; future earnings vs. assets. But the reality is a good deal more complex. Even the originators of value investing, Graham and Dodd, in their 1934 classic, Security Analysis, stated that it is important to assess “favourable possibilities for future growth.” Today’s managers employ a wide array of analytical tools to support their analyses, with literally dozens of ratios, indicators and qualitative factors in the mix. Indeed, many growth managers employ value measures to aid with their “sell” decisions and many value managers employ some growth-type analysis to determine what the catalyst will be that will make the value of a stock emerge in future years. There are conservative growth managers who avoid deeply cyclical industries and place great emphasis on consistency; there are aggressive growth managers who pay steep premiums to participate in the growth of companies on the verge of dominating their businesses.

A few ways to define investment funds

• Asset class: bonds, stocks, income trusts, real estate, mortgages, treasury bills, alternative investments, venture capital
• Geography: global vs. regional funds

Within bonds

• Issuer: corporate vs. government issues
• Credit quality: low to high

Within stocks

• Market capitalization (i.e., total value of outstanding company shares): small cap (e.g., <$2 bn. market cap), mid cap (e.g., $2 bn. to $10 bn. market cap), large cap (e.g., >$10 bn. market cap)
• Sector: healthcare, financial services, natural resources
• Style: value, growth, blend