Apart from measuring a standard ROI (return on investment) or avoiding investment losses, investors often have very different objectives when approaching the way they place funds. Objectives may be driven by any number of things, including personal risk tolerance, life circumstances, tax considerations and relative time horizon of the investment. What follows are a few descriptions of various, common investment objectives, including the incentives and rationale behind them.
Typical growth investors seek high rates of growth and capital appreciation. They are willing to tolerate more risk and will invest in growth stocks that have high P/E (price-to-earnings) ratios. Companies with high P/E ratios are typically looking for future performance to make up the price premium on the current earnings. If the company fails to create the expected earnings growth couched in the P/E ratio, then the share price will fall. Growth companies can see wild downward swings in the value of their stock when this occurs. Growth investors are not after the income from dividend-paying stocks, but are more interested in capital appreciation and capital gains as the profits from these types of businesses are plowed back in to facilitate more rapid growth.
Similar to growth investors, Aggressive Growth Investors focus on companies that have high P/E ratios, but they are looking for the very highest growth potential possible. These types of investments are reminiscent of venture capital investors. Aggressive growth stocks typically couple the highest growth rates with very risky companies. In some cases (especially in instances where earnings do not yet exist), these types of stocks have ridiculously-high P/E ratios. Those seeking an Aggressive Growth strategy typically need a very high tolerance for risk.
Capital Appreciation Investors are long-term investors. They seek capital appreciation growth over a very long and extended period of time. Appreciation in this case could be deemed “increase in value.” Many such investors are not interested in growth per se, but are looking to build value over the long haul. An example of this type of investment could include money placed in a 401(k) or IRA plan.
“Value investing” is a term often attributed to the late Ben Graham (venerable sage to billionaire investor Warren Buffet). A value investor seeks stocks whose value is often underpriced in the market. The types of stocks invested in by value investors typically have low P/E ratios and tend to be overlooked by the market. Another key component of value investing is to go after investments whose underlying business assets are extremely sound. Value stocks do not necessarily simply have a low price, but will have a low price relative to the earnings they produce (when compared with other possible investments). Value investors are under the assumption that the market will eventually take notice of the undervaluation and the stock will subsequently rise.
GARP investors combine some of the aspects of value investing and growth investing. That is, they seek high potential for growth while maintaining a reasonable P/E ratio. This is more difficult than it sounds, particularly if one assumes there is very little room for arbitrage opportunities. Stocks that appearl to GARP investors are typical in the middle of the road, however. That is, they may have slightly higher P/E ratios than value stocks and slightly lower expected growth rates than your typical growth stock. They will have vague characteristics of both, however. Put differently, GARP investors are typically looking for stocks with low PEG (price-to-earnings growth) ratios.
Income investors are likely the most risk averse of all those listed here. They typically seek reliable income and capital preservation. They will generally pick “blue chip” stocks that pay reliable dividends. In general, income stocks are typically less volatile than growth stocks are are more interesting to those seeking reliable regular payments. In fact, many retirees have interest in income-generating stocks. These types of investors will often invest in bonds or investments that are perceived as relatively stable with less risk. Due to their lack of relative volatility and stable payments, income stocks/bonds are typically referred to as defensive investments.
While many of the aforementioned investment objectives can and do work in tandem, oftentimes investors use them in a mutually exclusive fashion. That is, investors often silo themselves in their approach to investing, not venturing into other realms until they meet an asset, age or investing milestone or threshold. What’s your investment strategy?