Growth or value?
Two ways of making money from the same market, and why they work in different periods.
Two different bets
A growth stock is expensive relative to the profits it has now, because the market expects those profits to multiply. The bet is that the growth will come.
A value stock is cheap relative to its own profits, because the market expects little. The bet is that the future won't turn out as bad as the price suggests.
Both can work. They fail differently: growth fails when the growth doesn't come, value fails when the company was cheap for a good reason.
Why interest rates decide which one wins
A growth company's profits sit mostly in the distant future. When rates rise, that future is discounted more harshly and today's value falls a lot.
A value company's profits are mostly now. Rising rates touch it less, because there is less future to discount.
That's why growth dominates in low-rate periods, and value comes back when rates climb. This isn't fashion; it's arithmetic.
The “cheap” trap
Companies that look cheap are often cheap because the business is slowly dying. This is called a value trap, and it is the main way value investors lose money.
The useful test isn't “is it cheap?” but “why is it cheap, and is that reason temporary or permanent?”.
A printed newspaper with a P/E of 5 is not a bargain. It is a business shrinking every year, and the market knows it.
Key terms in this lesson
- Growth stock
- A company whose price rests on the expectation of much bigger profits in the future.
- Value stock
- A company that costs little relative to the profits it already produces.
- Value trap
- A company that looks cheap because its business keeps shrinking.
Quick check
Why do growth stocks suffer more than value stocks when interest rates rise?
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