Money Matters - Investments. "I like stocks like I like socks, great quality for minimum price"

When you go into a clothes store, do you immediately head for the offers section to see if you can hunt out a bargain – or do you go to the new releases aisle to get the best quality?

Value / Growth

These are two sides of the same coin. There is this ratio called the P/E ratio, and it means the amount shareholder have paid for a share (price) over the earnings of the company per share (earning per share or EPS).

Typically, if a share is trading above 20 classical economics says the market is always right and this means that the markets have priced in an earnings rise for next year, this is called a growth company.

Obviously, the markets can be wrong and they could simply be speculating that a company might grow. An investor should check that the company actually will generate extra earnings this year. The price could be high due to ‘momentum’ investing – where people buy stocks based on how quickly the price is going up – regardless of whether the stock is worth paying that much for.

If a share is trading at a p/e of below 10 a behavioral economist would say that a share has had poor earnings and the stock has fallen out of favour, being dumped by the market that expects these poor earnings to continue. This is called a value stock.

Again, these stocks could be cheap for a reason, they could simply be unfortunate companies at the end of their lives, companies that nobody would want to own. Again, a host of momentum investors could have been selling or even shorting the stock due to a rapid downwards price correction.

Similar metrics exist for all the main asset classes – property, bonds etc.

Whether you are passive or active these two options exist as you can invest in trackers of the FTSE All-Share Value series, or alternatively the FTSE All-Share Growth series.

Size

Size can be very important. Some people only invest in big, well capitalised companies, and some people only invest in smaller companies and venture capital. This applies to geography as well, some people only invest in developed countries with a transparent agenda, and some only invest in emerging economies, where it is a little more volatility economically and politically.

I have no particular preference here but the arguments are that:

Large companies have huge reserves and can continue to invest in the company, or pay out dividends, for many years and can afford to take on the short term projects that will cost them money over the short term – but will make the company much more profitable long term.

The downside of this style is that the large company can drift along investing in these modernisation packages for years without getting anywhere. Large companies are not always going to be large companies – nor are they likely of still being there in the future. From the original FT 30 in 1934, only four of those companies are still in the FTSE 100; GKN, Tate & Lyle, Rolls Royce and Imperial Tobacco.

Contrary to this, the smaller company investor believes that by investing in start-up companies that are more maneuverable; they can take advantage of market change rapidly and become large companies over the years – they are investing in the FTSE 100 of the future and one can get returns of the markets as well as that additional growth.

The downside is that the market changes and your smaller company is heavily invested in a particular market direction, leading to collapse.

Summing up

So now you should have an idea of whether you are active/passive, value/growth and large/small. We’ll talk through the final two areas next week.

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