Investing with style

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This article was published 16/12/2023 (973 days ago), so information in it may no longer be current.

Investors have plenty of approaches to make money in the stock market, but the biggest key to success is often sticking with a strategy for the long haul.

The holiday season involves a fair bit of idle conversation at parties on many topics from the Jets to the kids to even investing. If the last leaves you scrambling to say something incisive, fret not.

Here’s a primer on a few different investment styles. Understanding them may not only help when chatting with financial braggarts but also when meeting your investment adviser or thumbing through year-end RRSP statements as they roll in with the new year.

Growth: higher profits at all costs

Invest in the fastest growing companies with the fastest revenues and, in turn, profits.

Isn’t that what investing’s all about?

It is if you’re a growth investor.

“Being a growth investor means you are seeking out companies that are expected to achieve higher levels of revenue growth in the future,” says Michael Williams, Toronto-based director of portfolio advice at RBC InvestEase, the bank’s robo-adviser service.

Growth investors typically look at companies’ historical earnings growth, profit margins, returns on equity and share price performance, he adds.

Although it’s important to most investors, growth investors are looking for a high probability that all those factors will continue at their current pace or accelerate in the future.

Some sectors are better suited for growth, notably technology because companies like Apple, Microsoft and Alphabet (Google) have demonstrated rapid revenue and profitability growth. And investors expect that performance to keep on trucking.

Low interest rates had fuelled growth sectors like technology and biotech, making their future earnings — which aren’t guaranteed — look much better than the free lunch of government bonds, which paid less than two per cent until interest rates soared. Now, many growth stocks have lost their shine — except big tech companies with artificial intelligence exposure. Referred to as the Magnificent Seven, these include Google, Microsoft, Tesla, Amazon, NVIDIA, Apple and Meta Platforms (Facebook).

Value in ‘cigar butts’

FAMOUS investor Benjamin Graham — who authored The Intelligent Investor — described value investing as looking for “cigar butts where you’re looking for stuff with a little bit of value left in it, and buying it for pennies on the dollar,” says Grant White, a portfolio manager with Endeavour Wealth Management and iA Private Wealth in Winnipeg. Consider it bargain shopping for stocks that truly ascribes to the adage of buying low and selling high. Value investors use financial performance metrics to find undervalued companies, which is much harder to do than it sounds. A company with a low share price relative to its earnings, for example, is often cheap for a reason (i.e., a deteriorating business model). Yet value investing has made some investors very wealthy, notably Warren Buffett, chief executive officer of Berkshire Hathaway.

Investing according to GARP

Value investing has generally outperformed growth investing until interest rates fell in the late 2000s and stayed that low for more than a decade. Yet often companies that were once good value investments — low-cost relative to good performance — become growth companies. And good growth companies can fall out of favour and become strong value investments. That’s why sometimes the best approach is a hybrid called ‘growth at a reasonable price’ — or GARP for short. GARP investing involves finding companies with strong growth prospects, but their share price is not excessively expensive. It also hints at the importance of using a variety of approaches to invest successfully, says Michael Thom, Toronto-base managing director of CFA (Chartered Financial Analysts) Societies of Canada. “There are strong arguments for style diversification rather than style selection … for individual investors,” he adds.

Own it all and forget about it

Exchange-traded funds (ETFs) have exploded in popularity in the last decade fuelled by the premise that beating the overall stock market over many years using growth, value or GARP is almost impossible even for the best investors. In turn, why not just own the market — like the TSX Composite Index — for a sliver of the management cost of mutual funds that use value, growth and GARP approaches (among other strategies)?

Yet even owning these markets via low-cost ETFs often inadvertently involves value or growth slants because of the nature of the indices they track, Williams says. “The S&P/TSX Composite Index … tends to be more highly concentrated in more value-oriented and mature businesses as part of its composition,” which includes banks and resource companies but not a lot of growth sectors like technology and health care. In contrast, an ETF tracking the U.S.-based NASDAQ, considered a technology index, reflects a more growth-oriented approach.

A final style point

Pick a style or try a few of them. But if you do, stick with your choices for the long term because styles (and the stocks that embody them) tend to fall out and then come back in favour over many years. What hurts investors is buying stocks (or funds) based on one approach, only to sell those investments when the approach doesn’t seem to work. Then they try an entirely different strategy. That cycle of chasing returns often leads to subpar portfolio performance, White notes.

“Human nature compels us to run away from pain and keep trying to find something that works, but if you stay disciplined, you will probably be far more successful than constantly switching from strategy to strategy.”