April 22, 2024

Should You Buy Value Stocks or Growth Stocks? Warren Buffett’s Investing Advice May Come as a Surprise.

Investors often group stocks into two broad categories: growth and value. Some even define themselves based on which quality they see as most important. Growth investors generally focus on companies expected to grow sales or earnings more quickly than the market average, while value investors generally focus on companies trading at discounts to their intrinsic values.

Both strategies have merits and faults. Growth stocks may offer more upside, but that benefit comes with greater risk and volatility. Conversely, value stocks may offer less upside, but that drawback is often counterbalanced by more stable returns. So is it better to buy growth stocks or value stocks?

Warren Buffett has weighed in on the topic a few times over the years, and his answer may surprise you.

A well-dressed man looking at a computer.

Image source: Getty Images.

Warren Buffett views both value and growth as important qualities

Warren Buffett is one of the most accomplished investors in American history. He has built a personal fortune exceeding $100 billion, and he has transformed Berkshire Hathaway from a small textile business into one of the largest companies in the world. Both achievements were made possible by his remarkable ability to pick winning stocks.

Buffett is often called a value investor. In fact, he studied economics at Columbia University under the legendary Benjamin Graham, a man often called “the father of value investing.” Buffett himself leaned into that mindset early in his career, believing value stocks to be superior to growth stocks. But insight born of experience eventually led to a change of opinion.

Buffett wrote the following in his 1992 letter to Berkshire shareholders:

In our opinion, the two approaches are joined at the hip: Growth is always a component in the calculation of value, constituting a variable whose importance can range from negligible to enormous, and whose impact can be negative as a well as positive.

In addition, we think the very term “value investing” is redundant. What is “investing” if it is not the act of seeking value at least sufficient to justify the amount paid?

Buffett went on to explain that investors often conflate low valuation multiples with undervalued stocks, but they aren’t the same thing. Valuation multiples mean nothing out of context. For instance, there’s no way to determine whether a price-to-earnings (P/E) ratio is high or low without some idea of future earnings growth.

Indeed, a stock trading at a traditionally cheap P/E multiple may actually be expensive if the company lacks growth prospects. Likewise, a stock trading at a traditionally expensive P/E multiple may be cheap if the company has robust growth prospects. Context makes all the difference.

Buffett returned to the value-versus-growth debate in his 2000 letter to Berkshire shareholders:

Market commentators and investment managers who glibly refer to “growth” and “value” styles as contrasting approaches to investment are displaying their ignorance, not their sophistication. Growth is simply a component — usually a plus, sometimes a minus — in the value equation.

The bottom line is that investors must consider both value and growth when evaluating stocks. Both qualities are important. Prioritizing one over the other is like trying to complete a puzzle with only half the pieces.

More investing advice from Warren Buffett

Buffett once said investing is as easy as “picking good stocks at good times and staying with them as long as they remain good companies.” That pithy statement contains three distinct pieces of advice, and all of them are equally important

First, investors should buy only good stocks. Buffett believes the most important quality a business can possess is a durable economic moat, meaning some advantage that protects it from competition. In general, economic moats boil down to pricing power or cost advantages.

Second, investors should buy stocks only at good times. As discussed, Buffett believes valuation should be considered in the context of growth prospects. Analyzing those attributes is not an exact science, but the discounted cash flow model can help investors determine where a stock trades in relation to its intrinsic value.

Third, investors should buy only stocks they feel comfortable holding long term. The market is not always rational, meaning good stocks can lose value for nonsensical reasons. Investors can eliminate the impact of this volatility with a buy-and-hold strategy.

Putting those three pieces of advice together requires practice and patience. But investors who follow Buffett’s blueprint are more likely to be well rewarded for their efforts.

Trevor Jennewine has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Berkshire Hathaway. The Motley Fool has a disclosure policy.

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