Finding a bargain in the Nigerian stock market through growth and value stocks
The Nigerian stock market has potentials and has proven to be a haven for investors—both local and foreign. Being able to identify stocks that will deliver returns in as short a time as possible is key to a healthy portfolio, especially in a volatile market.
One classification that is quite common when distinguishing types of stocks is the growth and value stocks classification. These two stock types are critical in ensuring that as an investor, you find good bargains and enjoy decent returns on your investments. But what exactly are growth and value stocks and where does the difference lie?
Growth and value stocks investing are modern portfolio selection strategies and behavioural theories that could be deployed by investors to maximize returns and minimize risks in the stock market.
Growth stocks are stocks that are still growing but have the potentials to deliver great returns in the future or outperform the market. These stocks are in the early phases of business, but showing promising signs to be future winners. In Nigeria, growth stocks typically deliver double-digit revenue growth yearly and it’s irrelevant if they report profits or not. In fact, most growth stocks are expected to report losses because it is expected that they spend a lot more on marketing, advertising and any activity that is required to strengthen their business operations.
Where does it come from? Growth companies are considered to have a good chance for considerable expansion over the next few years, either because they have a product or a brand that is projected to sell well or because they appear to be managed better than many of their competitors and are thus predicted to gain comparative advantage over them.
Where does it come from? The returns on growth stocks are usually through capital appreciation, rather than from dividends. This is because the underlying companies mostly prefer to reinvest retained profits in ongoing or new capital projects. This is a key attribute of growth stocks—albeit dividends are sometimes paid to shareholders, it’s not a common occurrence.
In the Nigerian Stock Exchange growth stocks are mostly found in the technology sector. Many investors usually wrongly interpret growth stocks as stocks that attract high valuation despite not having any performance history. Growth stocks are seen as high quality stocks whose earnings are expected to continue growing. In general, the stocks have high Price-to-earnings (P/E) ratios and high Price-to-book ratios, and are sometimes seen as expensive and overvalued.
Value stocks on the other hand are stable, less risky and well-established companies that are trading below the what they are believed to be worth and show strong fundamentals—deliver moderate but steady revenue growth, profits and pay regular dividends. Value stocks are undervalued, and are out of favour with the market due to poor operating results or slowing growth. A value stock is cheap relative to some measure of its intrinsic value.
Value stocks tend to trade at a lower price relative to their fundamentals (including dividends, earnings, and sales). Due to value stocks having low (P/E) ratio, they are often seen as bargain stocks by investors who buy them in the hope that they will soon rebound to reclaim their true value. When this happens, the share price of these stocks start to rise relative to new information pertaining to their profits or dividend announcements.
Value stocks are companies that are undervalued, and are out of favour with the market due to poor operating results or slowing growth. A value stock is cheap relative to some measure of its intrinsic value.
In the Nigeria stock market, in recent years, some stocks, have traded at price earnings ratio that is below three times their earnings. Investors feared that the stocks might deliver losses on the back of a poor economy; and as a result assigned low earnings multiple to their valuation. However, as results trickled in, they showed record profits instead of declines, making investors to realise that the stocks were worth a lot more than they appeared. Value investors are expected to have acquired shares in the stock because they know that their fundamentals are strong and they will be rewarded bountifully in the future.
Sometimes, value stocks may have prices that are below the stocks historic levels or may be associated with new companies that aren’t recognized by investors. They may also have been affected by a problem that raises some concerns about their long-term prospects—such as recently poor operating results and negative outlook. Due to the sombre nature and negative outlook of these stocks, investors overreact and value them lower than they should be.
To maximise returns in the NSE, investors should endeavour to buy cheap value stocks that sell below or close to their intrinsic value.
Before the introduction of investors' and exporters' window by the Central Bank of Nigeria, the stock market assigned very low price earnings multiple to stocks, even though there were visible signs that the economy was turning around. Vigilant value-stock investors see these signs and quickly buy the stocks. Value Stocks usually have low P/E ratios and low Price/book ratios.
The difference between growth and value stocks lies mainly in the way they are perceived by the market—the investors. Growth stocks, are preferred by the wealthy investors. Such stocks usually exhibit sustained and rapid growth in revenues, highly-priced stocks, higher PE ratio, price to book and low dividend yield than the value stocks. On the other hand, value stocks are unwanted lowly priced stocks, such stocks have higher dividend yield but with disappointing earnings, lower price to book ratio and PE ratio amongst other disappointing financial fundamentals. Value stocks are sought after by the patient investors and growth stocks are demanded by impatient investors.
There could be rotational benefits between the growth and the value portfolio, as growth and value investments tend to run in cycles. Understanding the differences between them may help you decide which may be appropriate, helping you achieve your specific goals. Irrespective of which type of investor you are, there may be a place for both growth and value stocks in your portfolio and they may help you manage risks and potentially consolidate your returns over time.