When stock market “experts” discuss the market, they often divide stocks into industry categories: industrials, utilities, financials, electronics, etc. There are many such categories. But I have found that a simple categorization of stocks into two types—value stocks and growth stocks, can be very useful in protecting capital.
Growth stocks are stocks of companies with rapid growth prospects (e.g. 15% a year or more expected growth in earnings). These stocks are typically well regarded in the marketplace, get lots of press and trade at expensive price/earnings multiples. Examples if such stocks are Intel, Microsoft, Cisco, Dell and many other technology and internet companies. Growth stocks do best during “hot” markets as we have experienced the last few years.
However, during declining markets, growth stocks lose the most. In fact, it’s common to see a hot growth stock lose 50% of its value in 2 weeks when the market turns down or the company has disappointing earnings report.
Value stocks are typically less well regarded than growth stocks. They have slower growth prospects and are not as sexy or popular. Such companies include AT&T, General Motors and du Pont. They do not advance as rapidly during up markets as do growth stocks.
However, during down markets, value stocks tend to hold their value because they are not overpriced. They are not popular and an excited public has not inflated their prices.
Although it is not possible to predict market direction accurately (Peter Lynch says he can’t do it, Warren Buffet says he does not attempt it and John Templeton reports that he ignores market direction), you can take a more defensive position during those periods when you think the market is weak. You take a defensive position by switching out of growth stocks into value stocks.
For our clients, we always stay with value stocks during all markets because protection of capital is of prime importance in our philosophy.
If you would like to see how value investing has proven to help conservative investors protect capital, we are happy to send you 2 articles. Please check the enclosed coupon.
Note that investments compared to CDs and T-Bills are not insured while CDs are FDIC insured and the federal government guarantees T-bills. Nothing herein is intended to be legal or tax advice. Readers are encouraged to consult their accountant or attorney. Mention of a particular investment should not be considered a recommendation. Recommendations can only be made by determining your suitability. Past performance is not a guarantee of future results. Any rates quoted herein are subject to change. The S&P 500 and Dow Jones Industrial Averages are weighted, unmanaged indexes. Mutual fund performance figures are from Morningstar Principia as of 6/30/98. Stock market measurements are taken from Ibbotson and Associates 1997 Yearbook. Performance measurements of the Dow 5, 10, Fair Value portfolio and mutual funds are as of December 31, 1997 (unless otherwise stated) and include reinvested dividends and are before deductions for management fees or transaction costs.