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Value vs. growth stocks -- are you trapped?

Posted Dec 27th 2006 10:46AM by Sheldon Liber (RSS feed)
Filed under: Market Matters, Newsletters, Columns, Define Investing

I lean heavily toward the value side of the investment world and it has served me well. It is also the most successful and proven method of investing in the stock market. However, Barron's (subscription required) Market Watch section last week printed an excerpt from a newsletter titled "Beware 'Value Traps" which I thought was worth sharing with our readers.

The Stock Market, by Russ Kaplan's Heartland Adviser (December 2006): "We have always thought the distinction between growth and value is an artificial distinction. A lot of stocks we have recommended have been classified for a long time as growth stocks, but they have fallen in price to such an extent that they meet our criteria for value. In addition, a company that has no prospect for growth in its earnings, no matter how undervalued, is not a stock that we would recommend, and has often been termed a value trap."

Value Trap Defined (courtesy of thefreedictionary.com): A stock that has experienced a large price depreciation and is mistaken to be a value stock. Notes: When a company's stock seems undervalued, investors are sometimes drawn into purchasing it in hopes of stock price appreciation. If stock price is the only factor an investor looks at before buying a stock, he or she could end up with a stock whose value is likely to decline even further.

There are many things that draw us to examine a potential investment opportunity. But nothing grabs our attention like a 'bargain' (value) or a 'hot' (growth) stock. I would venture to say that for the most part impatient investors and less experienced investors tend toward momentum. The latter because they are drawn to the headlines and the former because they want to see a more immediate reward. The bargain hunters are definitely a more patient breed of investor, and almost by definition look for something that may have temporarily fallen out of favor or is as yet undiscovered. Of course, what one sees value in others may not, and the value remains undiscovered or under-appreciated and goes nowhere -- a potential trap.

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