Value vs. Growth
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By Dow Jones

Valuation begins and ends with profits. Just about everybody agrees with that. The faster a company's earnings grow and the more reliable they are, generally the more investors will pay for its stock.

When it comes to strategy, though, Wall Street is decidedly less single-minded. Everybody wants to buy low and sell high. But how low is low and how high is high?

Generally, the Street is torn between two camps: Growth and Value. Growth investors believe in buying stocks with above-average earnings growth no matter what the price. Value investors look exclusively for "bargains," or stocks that are trading at a discount to their usual valuation.

Which strategy makes the most sense? There's no right answer � people have the potential to make money both ways. But there are several reasons why we think a value approach is superior, particularly for long-term investors.

First of all, history shows that when you buy stocks that are cheap relative to others, your returns can benefit over time. It's easy to see why. Suppose you're looking at a stock that typically trades in a P/E* range between 20 and 30. If you buy it at 20 and let it move up to 29 before you sell, you clearly see a bigger profit than if you buy at 27, let it move up to 30, and then sell when it starts to head back down. Even if you ignore short-term cycles and hold it for the long term, you're better off if you buy the stock as cheaply as possible in the first place.

*P/E is a ratio derived by dividing the current stock price by an earnings figure. The price can be divided by the current fiscal year earnings estimate or the trailing 12 months' actual earnings. Although P/Es are subject to wide fluctuations over time due to price as well as earnings, a low P/E is typically more favorable than a high P/E.

The danger, of course, is that your company has problems that justify its low valuation. What if it stays at 20 and holds your money hostage. That's something growth investors rarely have to worry about. But if you choose companies that are in good financial shape and there's an explanation for why their stock is selling cheap, chances are the shares will likely resume their growth eventually, though it's important to remember there is no guarantee. And if they don't budge off the bottom, you really haven't lost much. That isn't true if you mistime1 your exit from a volatile high-multiple stock and get caught in a downdraft.

The ideal stock, of course, will have a low P/E and a rapid rate of earnings growth. Unfortunately, such situations are rare since any whiff of growth attracts investors and boosts the price. But that doesn't mean there aren't times when a stock is selling at a much lower price than it should. You just have to be ready to pounce.

And that's really the point. Above all else, we believe investors should be opportunistic as they set out to build a balanced portfolio of stocks. You shouldn't miss the opportunity to own big, important companies. But you shouldn't pay too much for them either. The key is learning how to tell when it's time to buy.

1 Market timing is what an investor takes when trying to buy or sell a stock based on future price predictions. Timing risk explains the potential for missing out on beneficial movements in price due to an error in timing. This could cause harm to the value of an investor's portfolio because of purchasing too high or selling too low.

©Dow Jones and Co., Inc. All rights reserved.

This material is authored by Dow Jones and was not authored by Merrill Edge. Assumptions, opinions and estimates constitute judgment from Dow Jones as of the date of this material and are subject to change without notice. Past performance does not guarantee future results. The information contained in this material does not constitute advice on the tax consequences of making any particular investment decision. This material does not take into account your particular investment objectives, financial situations or needs and is not intended as a recommendation, offer or solicitation for the purchase or sale of any security, financial instrument, or strategy. Before acting on any recommendation in this material, you should consider whether it is suitable for your particular circumstances and, if necessary, seek professional advice. Any opinions expressed herein are given in good faith, are subject to change without notice, and are only correct as of the stated date of their issue.

Investing in securities involves risks, and there is always the potential of losing money when you invest in securities.


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