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Home / New Zealand

<I>Learning about shares:</I> Look out for the bargains and back 'em like Buffett

29 Apr, 2004 05:27 AM4 mins to read

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By BARBARA KENDALL

Q. Barbara asks: I've heard terms like "growth" and "value" being used to describe shares and investing styles. What do these terms mean and which category should I fit into?

A. Dan responds: Growth investing and value investing are types of investment strategies. Everyone should have a strategy for
picking companies to invest in. Having said that, your preferred strategy doesn't need to pin you into any corners. A carefully planned combination of growth, value and other investments can give your portfolio a good balance.

You've probably heard of investment guru Warren Buffett, said by many to be the greatest investor the world has known. With a fortune of some US$30.5 billion, he is the second-richest person in the world (Forbes.com) and snapping at Bill Gates' heels. And he amassed it all in the sharemarket.

What you might not know about Buffett is that he is a value investor. He has stuck hard and fast to his chosen strategy -- even turning his back on the dotcom fever of the late 1990s, when rocketing internet stocks made many fortunes. Buffett, criticised for his stance, had the last laugh when the dotcom craze crashed.

So what is value investing? I'll call on Cam Watson of ABN Amro Craigs in Tauranga to explain the investing style that has made Buffett the legend he is. Cam will also cover growth investing, another popular strategy.

Cam says:

* Value investing is like going shopping when the sales are on. Value investors shop around for quality, discount shares in exactly the same way as you might find a bargain pair of Italian shoes or the latest-model DVD player on sale.

The technique involves finding companies whose shares are trading in the market for less than their "book value". Book value is the total value of a company's assets (with "intangible" assets such as intellectual property and goodwill taken out).

A company's book value, when compared with its market value (calculated by multiplying the share price by the number of shares on issue) can indicate whether the company's shares are under- or over-priced.

But value investing doesn't mean going out and buying cheap, "penny dreadful" shares.

Value investors look for quality companies with earnings records and projections they believe the market has undervalued. They then hold those shares for the long haul, taking advantage of the rise in share price that earnings growth tends to bring over time.

Back to Warren Buffett. The often-quoted figures still amaze: his value investing strategy has taken the share price of Berkshire Hathaway, the company that holds Buffett's investments, from US$12 in 1967 to more than US$93,000 - and that's for one share - as we write this column a generation later. If you had invested US$10,000 in Berkshire Hathaway in 1965, when Buffett took control of it, you would have more than US$50 million today.

Of course, a value investing strategy won't guarantee you Buffett's fame and fortune. However, many investors who have adopted the key parts of his investing style - discipline, patience and identifying companies with great earnings potential - have had excellent results in the sharemarket.

* Growth investors buy shares in companies that are expected to grow at a faster rate than the market average. This can involve buying relatively new companies with great potential for growth.

Including some promising, carefully selected "growth stocks" in a diversified portfolio can increase your overall returns. But as with all high-return investments, this tends to come with more risk. Your NZX broker can help you decide if growth investing is suitable for you.

So what do growth investors look for? Higher than average price-to-earnings (PE) ratios are one indicator of future earnings potential. The PE ratio shows how many times a company's share price exceeds its per-share earnings. In general, a high PE means high projected earnings.

In contrast, value investors often look for a low PE ratio. Dan Dividend will explain the PE ratio in detail next week.

Fast-growing companies usually need every cent of their earnings to pay for further expansion. Most re-invest their earnings back into their operations, so are unlikely to pay high dividends.

There's a lot more to this interesting topic than we're able to cover here, so if you would like to know more about the relative merits of growth and value investing, talk to your NZX broker.

A list of accredited firms is available at www.nzx.com

Email Cam Watson

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