One of the challenges in the investment world is deciding upon an investment style and sticking with it for the long run. In fact, many investors start out chasing high-growth stocks, which can offer high levels of volatility. This can often cause them to seek out lower-risk income stocks following disappointing results. Or even cheap stocks that may not be susceptible to the same amount of derating should results turn sour.
Clearly, no investment style is fool-proof. They all offer pros and cons, and here are three of the most common investment styles that you may wish to consider.
Easily the most exciting, growth investing relies on companies being able to consistently grow their earnings at an above-average rate in the long run. The end result of this can be a rapidly rising share price and high levels of capital gains for the investor.
However, growth stocks do not always work out as planned. Unforeseen challenges can hurt their financial performance and since they often trade on relatively high valuations, the cost of disappointing results can be a major fall in share price. Furthermore, growth stocks rarely pay high dividends since most of their excess cash is ploughed back into the business for future growth.
Income investing has become increasingly popular in recent years. That’s largely because of falling interest rates across the globe, which have caused the income return on cash and bonds in particular to come under pressure. Looking ahead, the popularity of income investing may remain high if as expected Central Banks around the world continue to adopt loose monetary policies.
Various studies have shown that the majority of total returns over a long period are from dividends. Income stocks also usually offer more defensive profiles than their growth counterparts, which provides their investors with a less volatile shareholder experience. And while a high yield may be tempting, sometimes a lower yield with a faster growing dividend can prove to be the most profitable type of income stock. That’s because it indicates management confidence in the company’s future outlook, as well as a strong financial performance.
Value investing gained popularity in the latter part of the 20th century thanks in part to the success of prominent value investors such as Warren Buffett. The idea behind it is simple: buy good quality stocks when they trade at less than their intrinsic value. The difference between intrinsic value and their current price is the margin of safety. The wider the better in terms of profit potential and reduced downside.
Clearly, value investing is highly subjective. There are numerous methods of valuing a company. However, perhaps the best approach is to find a valuation method and then stick with it, rather than changing it depending on the macroeconomic outlook. By doing so, it may be possible to unearth high quality stocks trading at discounted prices which have the potential for a major upward rerating.
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Fool contributor Peter Stephens has no position in any stocks mentioned.