Why Warren Buffett bought Apple years ago, and the crazy difference between growth and value stocks over time
You walk into a dark room at a travelling carnival.
You sit across from a one-eyed ancient woman who gives you chills.
“What do you want?” she croaks.
You decide to play along...
“It might be nice to be rich.”
“You money-chasers are all the same,” she says.
“You want quick gains, so you typically act along a continuum of foolishness.”
“Tell me,” you say, “What do you mean by ‘a continuum of foolishness?’”
She smiles, showing just three ragged teeth.
“If you were trying to maximise your money in the stock market, would you invest in a bunch of companies that promise to change the world… businesses with rapidly increasing corporate earnings? Or, would you invest in a bunch of businesses with slow corporate growth?”
“Of course, I would buy stocks of companies with rapidly increasing business earnings and huge future promise.”
The old woman smiles.
“You would put all your money in just a handful of high-flying stocks?”
“No,” you reply. “I would diversify into a basket of high-growth stocks, in case some of them tanked.”
“That’s only part-way along a continuum of foolishness,” she says.
“Have you ever heard of Warren Buffett?” she asks.
“He donates billions of dollars a year to charity…more money annually, in fact, than Donald Trump is even worth. And despite already giving away tens of billions of dollars, he’s still among the world’s richest men. Warren Buffett says his investment strategy is based 75 percent on Benjamin Graham and 25 percent on Philip Fisher.”
You have no idea what that’s supposed to mean. But she continues.
“Benjamin Graham was Buffett’s professor at Columbia University. He taught Buffett to buy low-priced businesses (often with slow-growing corporate earnings) because investors didn’t have high expectations for them. Such stocks are called value stocks. When those businesses had years when they recorded higher-than-expected business profits, it surprised investors who then rushed in and bid those stock prices up.”
“I’ve heard that,” you reply. “But who was Philip Fisher?”
“Fisher wrote a book called Common Stocks and Uncommon Profits. Buffett says his investment strategy is 25 percent Philip Fisher because Fisher taught him that it’s often worth buying companies that are quickly increasing their corporate earnings. But if you’re going to do that, you must pay a reasonable price for those stocks…not a silly price, as most people do.”
“Is that why Buffett bought Apple several years ago?” you ask.
“That’s exactly why,” she replies.
“But when Buffett buys anything, he’s always looking for good value. That’s why he says his investment strategy is 75 percent Benjamin Graham. He prefers stocks that are priced low, relative to their business earnings, because value stocks, typically beat growth stocks.”
“Wait a minute!” you reply. “You’re really saying value stocks beat high growth stocks?”
“In a diversified portfolio, over long periods of time, that’s true,” she says.
“Investors always have high expectations for growth stocks. As a result, when a growth stock’s business earnings don’t match or exceed expectations–even if the company still reported strong business growth–disillusioned investors often sell like headless chickens. Then those who paid a price that was too high (which most investors do) either lose money or they make little profit.”
“I view ten years as short term,” she says.
“But during the past 83 rolling 10-year periods, value stocks beat growth stocks 85 per cent of the time.
Longer term, the difference is even more dramatic.
If, in 1972, you invested $10,000 in an index of large US growth stocks it would be worth $1.48 million by July 31, 2022. But if it were invested, instead, in an index of large US value stocks, it would be worth $2.12 million.”
“That’s crazy!” you reply.
“Ah, but the difference is even more dramatic with smaller stocks,” she says.
"If, over the same period, that $10,000 were invested in medium-sized US growth stocks, it would have grown to $1.4 million. But if it were invested in medium-sized US value stocks, it would have swollen to $4.3 million.”
“What about small company stocks?” you ask.
“The difference is even more dramatic there,” she says.
“The same $10,000 would have grown to $1.07 million in small US growth stocks and a massive $6.5 million in small US value stocks between January 1, 1972 and July 31, 2022. You can check this yourself at the website portfoliovisualizer.com.”
“So, should I invest everything in value stock indexes?” you ask.
“Remember what I said about Warren Buffett,” she replied.
“His portfolio includes growth stocks and value stocks…with a higher emphasis on value stocks. As long as you have a fully diversified portfolio, you’ll have a decent representation of both. Just don’t solely chase growth stocks, like most people do, no matter how well they might be doing over a short time period.”
“How much do I owe you?” you ask.
She suddenly turned creepy again.
“Your firstborn grandchild will have to join my carnival. How else do you think I get new recruits?”
Andrew Hallam is the best-selling author of Millionaire Expat (3rd edition), Balance, and Millionaire Teacher.