How Risk And Return Factors Are Central To Your Portfolio Approach

The approach to investing and portfolio building should ideally be systematic and well-aligned with your overall goals and risk boundaries. In that context, there are two fundamental approaches or styles to investment selection – these are value investing and growth investing. While the former entails investing in companies that are perceived to be undervalued by the market, the latter seeks to invest in companies that offer a strong potential for growth. Clearly, each is distinct and can generate varying results over multiple time frames.

Value vs Growth – how do they differ?

There are several factors that distinguish the growth approach from the value approach.

Growth approach: This approach entails investing in companies that have a high earnings growth record and are expected to maintain a high growth trajectory in the future as well. Since these companies have an evident growth advantage, they tend to trade at higher price multiples. Further, due to the elevated prices, these stocks also tend to be fairly volatile as any negative news on the company or developments that could have a negative impact on the company’s earnings growth can have a sharp impact on prices. Thus, growth stocks are generally high-risk but also offer the potential for above-market returns.

Value approach: In this approach, investors seek to invest in companies that have strong fundamentals but might be available at compelling valuations due to temporary mispricing or setbacks. The basic premise underlying value investing is that due to behavioural biases, market participants often tend to overreact to negative news flows such as disappointing earnings, negative publicity or legal problems. However, many of these are temporary in nature and don’t impact the long-term fundamentals of the company. Value investors seek to invest in such companies. While they are generally more stable than growth stocks, their returns tend to be outsized if an investor patiently holds on to value stocks.

Which is better?

When choosing the right investing approach, you need to focus on the risk. As already highlighted, growth stocks tend to be riskier than value stocks and offer a higher potential for returns. However, it is important to note that many investors need stability in their investment portfolio and are comfortable with average returns as well. In such cases, value stocks would be better suited for the investor’s portfolio. A comparison between the Nifty Growth Sectors 15 Index and the Nifty 50 Value 20 Index (while not strictly comparable) could be instructive. Based on data retrieved on 28th March 2024, the growth index witnessed a 5-year total return of 13.70% and a standard deviation (used as a proxy for risk) of 19.61[1]. In the same time period, value generated a total return of 19.65% and a standard deviation of 17.58[2].

As is evident, the choice between the two approaches should ideally be tethered to risk as potential returns can fluctuate across time periods. Thus, it is important to understand your portfolio guardrails and goals and accordingly adopt an approach which is aligned with the same. Over the long term, what matters is the ability to stay invested over longer timeframes and being patient with one’s investment.

Note:

[1] https://www.niftyindices.com/Factsheet/Nifty_Growth_Sectors15.pdf

[2] https://www.niftyindices.com/Factsheet/Nifty50_Value20.pdf

Rajesh Kaura, Founder & Owner, Moneyzone

Disclaimer

The views are personal and are not part of the Outlook Money editorial Feature.