Is growth investing superior to value investing?

The biggest driver of long term returns is return on capital, not valuation

Question: Is growth investing superior to value investing?
Position1 of 2›: Growth investing is superior because it focuses on compounding for the long term, whereas value often buys low quality companies that can't grow
Argument: The biggest driver of long term returns is return on capital, not valuation

“Over the long term, it's hard for a stock to earn a much better return that the business which underlies it earns. If the business earns six percent on capital over forty years and you hold it for that forty years, you're not going to make much different than a six percent return - even if you originally buy it at a huge discount. Conversely, if a business earns eighteen percent on capital over twenty or thirty years, even if you pay an expensive looking price, you'll end up with one hell of a result.” Charlie Munger

The argument

People who invest in stocks can be grouped into two categories: growth investors and value investors. Growth investors invest in small, emerging companies that are projected to make above-average earnings compared to the rest of their respective industry. If these companies are successful, then investors can make large amounts of money, but there is also much risk associated with this because it is hard to predict how a company will perform in the long-run. The key characteristics of growth funds are as follows: - Higher priced than broader market. Investors are willing to pay high price-to-earnings multiples with the expectation of selling them at even higher prices as the companies continue to grow. - High earnings growth records. While the earnings of some companies may be depressed during periods of slower economic improvement, growth companies may potentially continue to achieve high earnings growth regardless of economic conditions. - More volatile than the broader market. The risk in buying a given growth stock is that its lofty price could fall sharply on any negative news about the company, particularly if earnings disappoint Wall Street. Growth investing is superior to value investing due to its compounding for the long term. While there is much risk, there is also the chance of a higher return.

Premises

[P1]Growth investing targets small, emerging companies expected to deliver above-average earnings, accepting higher prices and greater volatility in exchange for high earnings-growth records that can persist regardless of economic conditions. [P2] Though this carries real risk—prices can fall sharply on disappointing news—the strategy's compounding of earnings over the long term offers the chance of higher returns than value investing, which often buys lower-quality companies. [C] Growth investing is superior to value investing because it compounds returns over the long term.

Counter-arguments

Value fund managers look for companies that have fallen out of favor but still have good fundamentals. The value group may also include stocks of new companies that have yet to be recognized by investors. The key characteristics of value funds include: - Lower priced than broader market. The idea behind value investing is that stocks of good companies will bounce back in time if and when the true value is recognized by other investors. - Priced below similar companies in industry. Many value investors believe that a majority of value stocks are created due to investors' overreacting to recent company problems, such as disappointing earnings, negative publicity or legal problems, all of which may raise doubts about the company's long-term prospects. - Carry somewhat less risk than broader market. But, as they take time to turn around, value stocks may be more suited to longer term investors and may carry more risk of price fluctuation than growth stocks. Value investing is superior to growth investing because one can buy low with the potential of earning much back in return.

Rejecting the premises

[Rejecting P1] The body never argues the claim in the title: it describes growth funds as higher priced, faster growing and more volatile, which characterises a category, while the assertion that return on capital rather than valuation drives long-run returns appears nowhere in the reasoning offered. [Rejecting P2] "Higher risk with the chance of higher return" describes a distribution of outcomes rather than establishing that one approach is superior — and paying a high multiple in the expectation of selling higher is precisely the point at which valuation bears on the return, so the premise concedes the factor the title sets aside.