There are many different ways to invest in the stock market — day trading, growth investing, and value investing, to name a few. Which is the best method? If you want to gamble, become a day trader. If you are serious about investing your money in a disciplined fashion, consider value investing or growth investing. Or, why not take the best of both worlds? After all, that’s what the world’s greatest investor, Warren Buffett, has done.
What is value investing?
Broadly defined, value investing means buying a stock at a discount to its intrinsic value, or the fair value of the business. The tough part is the process of valuing a company. How do you value brand power, competitive advantages, customer loyalty, growth opportunities, or a spectacular CEO? You don’t. At least that’s what the hard-core value investors choose to do. They focus on asset plays, a strategy in which investors buy companies at a discount to the value of their tangible assets.
Case in point: Bank of America Corp (NYSE:BAC). Historically, banks trade substantially higher than book value. Banks trading below book value is a new phenomenon. In recent history, it wasn’t until 2008 that Bank of America Corp (NYSE:BAC) dipped — excuse me, plunged — below book value. To this day, the company trades at just 0.6 times book value while the rest of the industry, on average, trades at book value.
I happen to agree that Bank of America Corp (NYSE:BAC) is undervalued, believing the company has significant growth prospects. But this isn’t always the case. Sometimes companies trade below book value and also suffer the unfortunate circumstances of a declining industry. In these cases, traditional value investing won’t do you any good.
What is growth investing?
In growth investing, investors throw out valuation altogether. They look for excellent businesses with outstanding long-term growth prospects, investing on the premise that excellent businesses, over time, will outgrow their premium valuations. There are some good traits to growth investing, but it’s too simplistic; valuation might not always matter, but most of the time it does.