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Homework answers / question archive / Growth and value can be interpreted in different ways
Growth and value can be interpreted in different ways. Growth brings the notion that the portfolio focuses upon firms which have excellent future earnings per share (EPS). Small current yield, large price-to-book (P/B) ratio and large price-to-earnings (P/E) ratio are usual features of such portfolios. Value typically brings the idea of portfolios focusing or including only issues showing low P/B ratios, low P/E ratios, excellent dividend yield and undervalued stock prices. Required:
(a) Identify and explain why, over a long period of time, value equity investment will outperform growth equity investment. (6 marks)
(b) Explain why the consequence in (a) will be impossible in an efficient market. (4 marks)
A)Growth related equity investment will underperform the value related equity investment over a long period of time because value based investment is based upon the philosophy of finding the discrepancy between the intrinsic value of the company and current market price of the company and value based investor will be trying to invest into a zone where they will be finding appropriate value and they will be trying to capitalise upon the discrepancy between the price and the value whereas growth based investing does not depend upon the price of the stock and hence it will always be dependent upon the discounting of the futuristic earning into the stock price and they will be trying to invest into such firm, who are respective leader of their sectors and they are highly overvalued and highly growing firm but this cannot sustain for a longer period of time because when there would be downcycle in the economy it will mean that this shares will be highly prone to underperform because they are highly valued so these valuations will be stabilizing whereas the investors who are invested into value based securities will be investing into the fundamentals of the company and they will be making a higher rate of return because their investment is not sentiment driven but their investment is more like fundamental driven.
B) Efficient market hypothesis advocates that all the publicly available information and the Privately available information have already been discounted into the stock price and there is no scope for making any additional rate of return through discrepancy between the value and the price so it can be said that value investing is based upon the philosophy of making any additional rate of return through discrepancy between the price and value and capitalising upon it whereas under efficient market, there is no scenario under which an investor can beat the the market rate of return and hence it can be said that investors will not be allowed to find any stock which is undervalued because prices will be reflecting all the available information and efficient markets does not support fundamental analysis.
