Sunday, September 24, 2006

Value versus Growth and psychology

Before I start, it is of utmost importance to define what is growth. Growth is in fact a component of the value equation - sometimes a plus, sometimes a minus. However in general, most others think that Growth and Value are two different approaches in investing. For those who thinks so, it clearly shows their ignorance and superficial skills to investing, not their sophisication as assumed by them.

In a bull market, everyone seems oblivious to the danger that comes with pursuing stocks that belongs to the "Growth" school of thoughts. Those who can actually makes a pile from such way are those who can exit before the party ends. In the late 90s, funds that pursue the growth strategy, returns were up much more than those funds who pursue the value strategy. For most investor, they do not care if the fund pursues the value or the growth strategy, what they care is they do not want to miss out on the fund that makes the most money, even if it was speculative. In stocks, you can only exit when someone takes your place. So for those who are vested in the Growth stocks, those who really make a pile are those who cash out before the tumble.

The value strategy is always most discredited or disregarded during the bull market - almost out of fashion. Growth investors flip stocks like houses in the Hamptons because they are only interested in short-term results and the illusion of things being under control. This people are like drivers you see on the road weaving in and out of lanes, trying to get ahead as quick as they can. He gets behind you, then in front of you and then he bangs right into a trailer. Then the one who drives steady will turn his head to see what happens and then moves on.

For this, it is appropriate to mention what Pascal once said "All men's miseries come from their inability to sit quiet and alone." Buffett once said "Most success can be attributed to inactivity." But for most humans, people cannot resist the temptation to constantly move. They can't sit still. It takes discipline to appreciate the value way of investing.

Every investment strategy has its own risk. For the value investor, the risk is time. Sometimes, he may have to wait for years before the stock price reflects its value, staying flat for a couple of years.

In the bull market where prices are driven by the growth strategy, it makes sense to be out of the market especially when prices are driven way out of logical senses. If you are playing cards for money, you do not want to play with lunatics for it is impossible to guess what they might do next. As a value investor, during a bull market, it takes a whole lot of discipline to stay out of it while you see the market still ever advancing at a great rate. In the late 90s, it took a couple of years before the bubble finally was pricked, but it was a few years before that when the price is already driven out of senses. Unless you have a magical ball, then it is safe to pump in fresh funds in the bull market.

Those who pursue the growth strategy believes the market will always be ascending. That's why in the bull market, more people are tempted towards the growth strategy, because a bull market will only happens when stock prices has advanced for a few years before that. Psychologically, the longer the market rises, the more people will believe it will go up perpetually. But if you look at history, you know everything runs in cycles. But that's the way psychology works.

For a value investor, the lesson here is;

1) It is important to recognise the game of playing. If the game is not played your way, it's no longer your game and you should stop playing. The worst is for you to join the other side who is apparently winning for the moment. If you can't understand your game well, you can never play it correctly. It's always more important to protect your funds than to make much more because of greed overcoming one.

2) You could never expect to outrun the bull that had taken charge of the market. The only way to be on the same pace is to hop onto its back which is as good as joining those in the growth lane.

In investing, it is like building Rome, it takes years to build it solidly but if you stumble, it takes a day or two for it to fall like a stack of cards.

In most things you do, success does not comes with foolish risk-taking, though risk comes with everything. It is how you manage risk that determines success. Many will say that the more risky it is, the more returns you get, well, it is true to a limited extent. But for something to be successful throughout the lifespan of it operating, being risk-adverse and managing the risk to a minimal level returns the most.

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