Investing Today

By Dan Hreha

Investment style refers to a manager’s philosophy for selecting securities. The two purest equity investment styles are growth and value.

Because of the cyclical nature of the U.S. economy, value and growth stocks seem to perform well at different times. When growth stocks are in favor, value stocks may not be, and vice versa.

Value stocks often outperform the rest of the market during recovery stages of the general business cycle, and growth stocks often outperform during mature and recessionary stages.

Growth stock managers

Growth stock managers buy companies that have or are expected to have above average earnings growth. Often these companies are developing new technologies and products, or are well positioned in a rapidly growing industry.

Relative to the overall stock market, growth companies are characterized by basic financial characteristics, such as low dividend yields, high price/earnings ratios and high price/book ratios.

Growth style is generally appropriate for investors seeking an above average long-term total return, mostly through share price appreciation. Growth stock investors must be able to tolerate a high level of portfolio fluctuation over time.

Value stock managers

Value stocks are those that appear comparatively “cheap” based on various valuation measures. Value managers seek to buy undervalued companies and capture the returns that occur when the market price rises to properly reflect the company’s “hidden” or intrinsic value.

Managers measure value in different ways. Some look for companies having below-average price/earnings or price/book ratios, while others stress above-average dividend yields, and some emphasize a combination of both.

Value managers look for high-quality medium to large capitalization companies with sound balance sheet characteristics.

Value stocks are generally appropriate for investors seeking an above average long-term total return through a combination of capital appreciation plus income. Conservative investors often find value stocks appealing since their above-average dividends can be a major contributor to total return, and many serve as a “cushion” for their share prices, if prices temporarily fall out of favor with the market.

Core equity managers

Investors who are undecided about choosing growth or value stocks may prefer building a portfolio that combines both styles. Sometimes known as core equity portfolios, these managers maintain a well-diversified portfolio that blends growth and value with an emphasis on larger, blue-chip quality growth companies that have dominant industry positions.

The manager adds value compared to the index through superior stock selection and sector weighting differences, usually without making any big “bets.” A core equity portfolio is often considered the bedrock foundation on which other specialized investment management styles are built.

Style performance

Individual stocks do not respond equally to economic and fiscal environments. There are periods, often lasting several years, when growth stocks outperform value stocks (and vice versa).

Timing investment styles is difficult due to trends in market volatility, interest rates and the economy. Portfolio diversification offers one solution because it increases the opportunity that at least some investments will do well, offsetting others that are lagging. Portfolios generally experience less volatility when they blend investment managers with complimentary styles, while long-term performance is usually not hindered.

Investors who understand that related styles tend to produce similar long-term returns are more likely to possess the confidence needed to stay with an investment manager when its style is out of favor. Those who lack an understanding of style may become impatient and bail out of a good long-term investment at the worst possible time.

Dan Hreha is a financial advisor with UBS Financial Services Inc. E-mail him at dan.hreha@ubs.com.

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