Growth stocks and value stocks are two different animals. While the well-diversified portfolio includes both, most investors lean one way or the other. So which type of investor are you?
Some species of birds like to nest in tall evergreens and eat seeds, while others nest on cliffs and fish for a living. Some migrate and some stay put. The differences are fairly profound, and seem to be hard-wired into the birds’ tiny brains.
In much the same way, different types of equity investors prefer different stocks. Growth investors like to put their money into stocks that are going up, while those who prefer the value style are fascinated by stocks that are in the cellar. And while most of us like to think of ourselves as supremely rational, these preferences seem to be built into our personalities at a very deep level.
How else can you explain the preference of many investors for low-priced stocks? No matter how many times you explain that $1,000 invested in 10 shares of a stock that trades at 100 is exactly the same amount of market exposure as 100 shares of a stock that trades at 10, people still love to buy the lower-priced option. If either stock rises 5 percent, the investor’s gain is still just 5 percent, either way. And if the more expensive stock splits, the investor may have twice as many shares, but the net worth of the stock is exactly what it was beforehand.
Just as there must be something deeply satisfying to some investors in owning a higher number of shares, there is something about value stocks—those that are out of favor and selling cheap—that appeals to others. This may be the same impulse that leads some people to buy merchandise on sale (especially if it’s a real “bargain”) whether they need it or not. Looking at the chart of a stock that has fallen from 48 to 12 gives the same thrill as seeing a price tag that says “75% off!”
And finally, not to leave growth stock investors out of the fun, for every investor who catches a stock low and rides it to big gains, there are two who will follow a rising stock for weeks, watching while it racks up gains and gets more and more expensive in terms of its valuation ratios. All too many of these investors will keep waiting until something clicks in their brains and they swarm into the stock … just in time for it to keel over into a steep correction.
The point isn’t that any of these built-in appetites for different kinds of stocks is wrong. Low-priced stocks are more volatile than higher-priced stocks, and they can make very satisfying gains very quickly. (Of course they can go down just about as quickly, but let’s leave that out for now.) Similarly, value stocks, while they may take a long time to get back to fair value, do have lower downside risk. And for investors who feel real pain when the price of one of their stocks declines, value may be the way to go.
And growth investing has the obvious advantage that rapidly appreciating stocks often keep right on appreciating. For some investors, not even the threat of bad news, climax tops and crazy valuations can dampen their enthusiasm for the emotional rocket ride that aggressive growth stocks can give.
Which brings us to the moral of our story! The most important thing for you to understand about investing in stocks is yourself. All the learning about companies and markets and technical indicators and fundamentals won’t do you a bit of good unless you know your own strengths and weaknesses. Do you look back at your biggest losses and try to figure out why you got in or out at the wrong time or at the wrong place? Do you know what kinds of stocks appeal most to you and what kinds of results you get from them? Do you review your portfolio occasionally to look for weakness? Do you understand how you got shaken out of a stock that then took off, or waited for a bounce from a stock that never came? As painful as it is, this kind of review is part of the hard work that separates Wall Street’s winners from its wannabees.
We’ll keep giving you good ideas, market timing indicators, hot stocks and cool commentary. But the real road to investing victory lies inside you. Remember that you can always ask us for help.