Most people asked to describe the difference between value and growth investing would stumble because these strategies are neither mutually exclusive nor collectively exhaustive. In fact, Warren Buffett argues that “growth is always a component in the calculation of value” and “the very term ‘value investing’ is redundant. What is ‘investing’ if not the act of seeking value at least sufficient to justify the amount paid?” Frederick K. Martin gives full form to this “joined at the hip” reality in Benjamin Graham and the Power of Growth Stocks: Lost Growth Strategies from the Father of Value Investing (McGraw-Hill, 2012).
Graham may be best known for his rigorous methodology for evaluating an investment, but “as his career progressed, he developed an appreciation for the long-term power of growth.” Later in his career he purchased a major stake in GEICO for $27 a share “and watched it rise over the ensuing years to the equivalent of $54,000 per share. … That single transaction, which accounted for about a quarter of his assets at the time, ultimately yielded more profit than all his other investments combined.” (p. 7)
Graham defined a growth stock as “one which has done better than average over a number of years and is expected to do so in the future.” In the 1962 edition of Security Analysis he devoted an entire chapter to analyzing and valuing growth stocks. “Brilliant in its common sense and simplicity, it was a landmark chapter in Graham’s illustrious career before it inexplicably disappeared from future editions of the book.” (p. 65) Martin reprints the “lost” chapter in this book—an important service in and of itself.
Martin expands on Graham’s growth ideas in seven chapters. Among the key principles is Graham’s valuation equation: value = current “normal” earnings x (8.5 plus 2G), where G is the average annual growth rate expected for the next 7 to 10 years. Martin also explains how to build a margin of safety for growth stocks and describes the characteristics of a great growth company. He hammers home the power of compounding and invokes Graham’s notion of “Mr. Market” to explain inefficiency in the market. And he gets down in the trenches, showing how to put Graham’s principles into action.
Benjamin Graham and the Power of Growth Stocks provides effective guidance for the long-term investor who wants to achieve above-average returns. Yes, the strategy requires work—and a lot of wasted effort, and this in itself “could be a deal killer for anyone who is not willing to be diligent in her investing practices. If she doesn’t enjoy the painstaking effort of poring through 10-K reports, analyzing balance sheets and cash flow charts, and making careful projections, she may be unable to execute Graham’s strategy effectively.” (p. 246) At least she doesn’t need to be a sophisticated quant. As the author argues, “higher-level math implies a level of precision that does not exist in the real world.” (p. 259)