value growth investing

Quality – A complement to “Value” and “Growth” Investing

The longstanding feud between “value” and “growth” has once again sparked debates amongst investors and financial professionals as recent inflationary concerns and global recovery triggered an event not seen since the 2008 financial crisis; Value outperforming Growth.

The longstanding feud between “value” and “growth” has once again sparked debates amongst investors and financial professionals as recent inflationary concerns and global recovery triggered an event not seen since the 2008 financial crisis; Value outperforming Growth. This has led to polarising views dominating the financial press as markets continue to navigate through these two camps. 

Difference between “Value” and “Growth” Investing

There are some misconceptions that categorising securities into either the “Value” or “Growth” bucket would need to follow a set of rules or guidelines. While there are differences between these two styles, what separates them are a range of generally accepted metrics usually applied by analysts, asset allocators and index providers.

Value investing is mainly represented by investing in securities that appear to be trading below their intrinsic value or book value following an age-old mantra of “buy low, sell high”. This style of investment would also include investing in businesses that have reached the mature stage in the business cycle and exhibit low P/E and P/B ratios. Investors who focus on this strategy usually are seeking to generate cash flows from dividends paid. When cyclical businesses were dented by the pandemic, the likes of consumption, energy and travel-related companies had piqued the interests of Value investors as economic recovery appears on the horizon with mass inoculations.

Growth, on the other end, focuses on increasing the investor’s capital. As its name implies, investors seek out young, small companies or disruptive sectors whose earnings are expected to increase at an above-average rate compared to the industry in hopes of generating large returns. The majority of Growth companies do not pay out dividends but are reinvested back into the business.

As both schools of Value and Growth each have their staunch and outspoken advocates, investors may be caught in a dilemma of swinging between the two styles – when they do not have to. There are often overlaps of the 2 styles and it is a challenge in itself to strictly define if a strategy is “Value” or “Growth”. Moreover, a company categorized as Value may evolve into Growth as it innovates and transform its traditional business model into a potential disruptor. A Growth company, on the other hand, would one day reach its maturity and begin to experience a slower growth compared to its early years. It may be prudent, therefore, for an investor to diversify and invest in strategies that had been loosely defined as “Value” or “Growth”.

Quality joins the party

Following the Dot-com bubble in 2001, the world witnessed multiple catastrophic business failures which led investors to pay closer attention to the company’s characteristics, financial statements, and business models. MSCI defines a Quality company as one which exhibits a combination of financial productivity, low leverage, and stability.

The beauty of Quality is that this investment process could be easily incorporated into Growth and Value investing models. By assessing a business’ earnings sustainability, stability and leverage with metrics such as debt-to-book value and how effectively a company deploys its assets to drive growth by considering its Return on Equity, it could provide a new dimension towards the investment process and possibly exploit opportunities which were previously not taken into consideration. This could also help in weeding out companies with abnormally high earning performance in a given period but would otherwise be unsustainable over the longer timeframe. In addition, the measurement of a company’s financial leverage provides investors with a clearer understanding of the potential default or bankruptcy risk a company might have undertaken.  

Corporate governance is also an essential component when evaluating the Quality of a company. High-quality corporate governance oftentimes aligns the interest of the management with the investors, thereby enhancing the investors’ returns. With strong corporate governance, long-term sustainable growth could be achieved. Good corporate governance structure, controls, practice or behaviours could effectively enhance the financial productivity and hence the Quality of the company, therefore making it a more ideal investment for investors.

Especially in this current economic environment, looking only within the four walls of quantitative factors may no longer be sufficient. The evolution of Quality investing serves as a complement to the age-old concept of Growth and Value investing. As investors seek attractive returns while keeping an eye on the stability of their investment, Quality may actually be on time for the party.