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Wednesday, July 7, 2010

Understanding Growth & Value Investing

There are two ways to think about investing in the stock market. You can think in terms of growth or value. They are different approaches, each with it’s own unique characteristics.

Growth Investing

Investing for growth means looking for companies that have potential to become a hot growth stock. Maybe they have a new innovative, unique, industry disruptive technology. Or maybe they are attached to some major news that’s being widely covered by the media. Currently, many health care stocks would be considered to have hot growth potential.

Another way a stock could grow is through acquisition. So these investors go around looking for public companies that are looking for buyers or have the potential to be acquired by another large company. Also, growth investors tend to look more at small cap stocks than at large caps.

Indeed there are mutual fund managers who specialize in growth funds, where they buy up companies with potential to grow or to be bought up. If you want to do growth investing but don’t have the time or resources to find these gems, these funds would be a good option for you.

Value Investing

Value investing is looking for companies with good fundamentals, i.e. a solid business model, good management, solid earnings, ongoing opportunities for future growth, no major defects, good financials and so on. You also want to find good companies with these qualities, but are trading at a discount.

That means looking for good companies that the market is undervaluing and buying them up when they are cheap. Warren Buffett is probably the greatest value investor in the world. This is how he has made his $40 billion of net worth, just by value investing.

There are also mutual funds that take the value approach. And you would think that most would go after large cap stocks, which many of them do. But surprisingly, many of them also small cap funds that go after value rather than growth. And the small caps have the added advantage that they are often overlooked by large institutional funds for a variety of reasons.