Growth versus value is one of the biggest and longest-running debates on Wall Street. For the past decade, growth stocks have outperformed value stocks. Over the past 50 years or so, however, value stocks have outperformed growth stocks.
Different measure
That being said, these figures vary depending on how you measure value and growth.
Growth stocks are generally defined as being expensive, and value stocks are generally defined as being cheap as compared to the rest of the market or by book value.
Both of these methods are imprecise and messy. For example, neither takes into account the power of network effects or brand value. The metrics only measure value based on figures displayed in annual reports or projected by Wall Street.
Warren Buffett (Trades, Portfolio) attacked this topic at the 2001 Berkshire Hathaway (BRK.A, Financial) (BRK.B, Financial) annual meeting of shareholders.
He was responding to one investor who asked if he could elaborate on comments previously made about the difference between growth and value stocks.
Buffett started his reply by saying he thought the shareholder was misquoting him. He then went on to add:
"So our position is that there is no such thing as growth stocks or value stocks, the way Wall Street generally portrays them as being contrasting asset classes.
Growth, usually, is a chance to — growth, usually, is a positive for value, but only when it means that by adding capital now, you add more cash availability later on, at a rate that's considerably higher than the current rate of interest.
So, there is no — we don't — we calculate into any business we buy what we expect to have happen, in terms of the cash that's going to come out of it, or the cash that's going to go into it."
To put it another way, the Oracle of Omaha seems to be saying that growth and value are both factors investors should consider.
Growth creates value, and companies that are snowballing can look cheap today compared to their long-term potential.
Berkshire the growth stock?
The guru went on to provide the example of Berkshire itself in the mid-1960s.
The company might have looked like a value stock (in fact, Buffett bought the business at the time specifically because he thought it was a deep-value play), but over the next few years, the CEO's ability to create value turned the company into a growth enterprise:
"If you had asked Wall Street to classify Berkshire since 1965, year-by-year, is this a growth business or a value business — a growth stock or value stock — you know, who knows what they would have said. But, you know, the real point is that we're trying to put out capital now to get more capital — or money — we're trying to put out cash now to get more cash back later on. And if you do that, the business grows, obviously. And you can call that value or you can call it growth. But they're not two different categories. And I just cringe when I hear people talk about, 'Now it's time to move from growth stocks to value stocks,' or something like that, because it just doesn't make any sense."
So that is something to consider the next time you are trying to distinguish between value and growth.
At the end of the day, it doesn't matter whether or not a company falls into either of these buckets. It only matters if the business is going to produce more cash and can reinvest it at attractive rates of return.
A high-flying tech stock might look like a growth investment because it has a high multiple, but investors have to ask themselves if the business is really cash generative, and what the stream of future cash flows is worth.
Disclosure: The author owns shares of Berkshire Hathaway.
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