As you can imagine, everybody seems to have their own take on how to invest wisely but if we take a step back and look down from a very high level – many people could fall into one of two broad camps of investment STYLES (there are more than this, but these are two of the most popular broad categories). These two "camps" are VALUE investing and GROWTH investing.
I have heard that value investing is "buy low, sell high" and growth investing is "buy high, sell higher" and I think that is a pretty good description to give you a basic understanding – although if you are taking a finance exam don’t select this answer as it’s more of a funny analogy than anything else! :)
Value Investing: Value investors are generally looking for stocks that are "temporarily" undervalued by the stock market. In other words the investor has looked at the balance sheet and earnings statements, looked at what management has discussed in the annual report and determined that the stock is probably worth about $50 per share – but they see that it is trading on the stock market at $30 per share. They see this as being undervalued – and will buy the stock. Warren Buffett made the phrase "margin of safety" a popular one in the investing world (although one of his mentors [Benjamin Graham] was the one who coined it) – and it refers to the difference between the intrinsic value (what the investors believes the stock is worth) and the market price (what the stock is trading at on the stock market).
In order for a value investor to be more confident on their valuation of the stock’s intrinsic value, they tend to look at companies that have a long track record, are profitable and generally pay out a dividend. In other words the company is not focused so much on expansion as they are on modest growth through sales and efficiencies.
A prime example of a value investment would be for a company like Coca Cola. They’ve been around forever, make a tonne of cash every year and predictably grow their earnings in a modest fashion. A value investor would wait for a pullback in the stock’s price before purchasing shares. The pullback would be due to some event not really related to Coca Cola per se – i.e. the general expectation that the world is going into a recession might pull back all stock prices temporarily, but since Coca Cola was materially the same company it was yesterday the intrinsic value of Coke stays the same. Hence the value investor would purchase shares of Coca Cola thinking that it would be just a matter of time before the market comes to it’s senses and prices Coke more closely to it’s intrinsic value.
Value stocks tend to have lower P/E ratios, high dividend yields and have a Beta below 1.
Value investors tend to be "buy and hold" investors – as it can take time for companies to realize their intrinsic values – and even after that they remain good companies that are producing a profit year over year, so there is no need to sell. If there are future pullbacks in stock prices – the value investors may simply ADD more stock to their current positions.
Growth Investing: As I alluded to earlier – growth investors buy high and sell higher! :) They are looking for companies that are going to become the NEXT Coca Cola. The companies these investors look at tend not to have dividend payments at all since the companies are aggressively trying to expand, they use all available cash to re-invest in the business’ growth rather than return the profits to shareholders in the form of dividends. Growth investing tends to be a bit more volatile – which means short term performance can be very impressive or equally depressing! Since these companies are still in the growth phase (or expansion phase) it indicates there may not be a solid track record of management, competitive barriers (i.e. trying to build up a distribution network to sell a soft drink in the same volume as Coke would take decades), but also the room for explosive growth. A growth investor would’ve bought Starbucks back when there was only one store at an intersection, instead of each corner of an intersection being occupied by a Starbucks franchise like now… :)
Growth stocks tend to have higher P/E ratios, pay little or no dividends and have a Beta above 1.