Definition

Growth vs Value Investing

Two labels for the same activity, and a distinction that costs people money.

Brian Feroldi

By Brian Feroldi, co-founder of Long Term Mindset

Investing since 2004. 3,000+ articles for the Motley Fool. Author of Why Does The Stock Market Go Up?

Last updated

Value investing is usually described as buying companies trading below intrinsic worth, and growth investing as buying companies expanding quickly. In practice both are estimating future cash flows and paying less than those are worth. Buffett's phrase is that growth and value are joined at the hip.

What the labels actually became

The distinction started as a description of method and ended as a description of screening criteria. "Value" came to mean low price-to-earnings and low price-to-book. "Growth" came to mean high revenue growth and a high multiple. Neither says anything about whether the price is justified, which was supposed to be the point.

That drift produces two symmetrical mistakes. Value investors buy statistically cheap companies whose earnings are about to fall, which is the value trap. Growth investors buy genuinely excellent businesses at prices that require a decade of perfection, which is the growth trap. Both bought a number rather than a business.

Why growth is a component of value, not its opposite

The value of any business is the cash it will produce over its life, discounted to today. Growth is one of the inputs to that calculation. A company growing at 15% is worth more than an identical one growing at 3%, and how much more is exactly the question.

The trap in both directions

Two companies, both trading at $60 a share.

A: earns \$6.00, P/E 10, earnings falling 8% a year
B: earns \$1.50, P/E 40, earnings growing 25% a year

After 5 years: A earns \$3.95/share, B earns \$4.58/share

The "cheap" one is now the expensive one. Neither multiple told you that, because a multiple is a snapshot of a single year and the businesses were moving in opposite directions.

The framing that works better

Replace the label with a question about where the company is in its life. A business in hyper growth should be judged on revenue growth, gross margin and customer retention, and valued on revenue multiples because it has no earnings by design. A business in capital return should be judged on ROIC and free cash flow, and valued on earnings.

Those are not two philosophies. They are the same discipline applied to companies at different points, and the phase tells you which metrics are even relevant. That is a more useful organising idea than a label that mostly describes what a screen returned.

What the historical data actually shows

Value outperformed growth over much of the twentieth century, then underperformed for most of the 2010s, then the relationship shifted again. Anyone claiming a permanent winner is describing a period rather than a law.

The more durable observation is narrower and less exciting: businesses that earn high returns on capital and can reinvest at those returns have compounded well regardless of which label a screen assigned them. That is a statement about business quality, and business quality does not care what style box it lands in.

Free tool

Skip the label, check the phase

Whether a company should be judged on growth or on cash generation is decided by where it sits in its lifecycle, not by an investing style. Phase Check answers that for any US-listed company in seconds.

Try Phase Check free

No credit card. One check without an account, unlimited with a free one.

Frequently asked questions

As commonly used, value screens for low multiples and growth screens for fast expansion. As originally meant, both are estimating what a business will produce and paying less than that is worth. The screening definitions have drifted a long way from the underlying method.
Buying businesses for less than they are worth is not dead. Buying statistically cheap companies on low price-to-book has worked poorly for long stretches, partly because book value captures intangible-heavy modern businesses badly. The method survives; one crude proxy for it has struggled.
Frequently, and those are often the best opportunities. A company growing quickly at a price that does not require heroic assumptions qualifies as both, which is precisely why the categories are less useful than they appear.
The leadership has alternated across decades, so any claim of a permanent winner is describing a sample period. The more durable pattern is that businesses earning high returns on capital and able to reinvest at those returns have compounded well under either label.
The company's lifecycle phase. It tells you which metrics are relevant and which valuation method will give a sensible answer, which is the practical work the growth and value labels are usually being asked to do and do badly.

Related

Run this framework on a real company

Stock Simplifier walks you through these steps for any stock, filling in real data at every one and explaining each concept as it comes up. You review it, score it, and reach your own conclusion. Every analysis is saved so you can check later whether your thesis still holds.

Create Free Account See pricing

Free forever. No credit card · Upgrade anytime.