Avoid a strict value company vs growth company strategy and instead focus on high-quality examples of each investment type for the biggest portfolio gains

How do you compare a value company vs growth company—and which should be in your portfolio? If you invest as we advise—by spreading your investments across the five main economic sectors, investing mainly in well-established companies and staying away from stocks in the broker/media limelight—you will automatically own some growth stocks and some value stocks.

That helps you achieve good results while potentially decreasing volatility. In the end, however, the relative amounts you invest in growth and value stocks are less important than your portfolio’s diversification and overall investment quality.

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Value company vs growth company investing: Target spinoff stocks that unlock hidden value—plus at the same time unleash growth potential

One of the ways a company can try to unlock its own hidden value is by creating a separate company out of a subsidiary. The parent company can either sell the public stock in the new company (most often through an initial public offering) or spin it off; i.e., hand the stock out to its own investors. In the past few years, it has become common to do both.

Sometimes, the parent company first starts by selling a portion of the new company to the public, to establish a market and a following among investors. That way, by the time of the spinoff, stock in the new company may be liquid enough to be sold relatively easily, or retained with some confidence as a worthwhile investment.

In our experience, and in most academic studies of the subject, both the parent and the new company created by the spinoff benefit: they generally do better than comparable companies for at least several years after the spinoff takes place.

Value company vs growth company investing: Avoid growth-by-acquisition approaches in both types of stocks to make sounder investments

Investors often underestimate the hidden risk of a corporate strategy of growth-by-acquisition. This strategy is inherently risky. It’s a little like buying new stock issues.

Acquisitions generally come on the market when it’s a good time to sell. That may not be, and often isn’t, a good time to buy. Insiders and managers at the selling company know a lot more than the buyers about the company itself, and its business strengths and weaknesses.

Some takeovers work out well for the buyers, of course. This doesn’t diminish the inherent risk. More important, the risk increases as takeovers become a habit.

Takeovers are more likely to succeed when the buyer is already a successful company and is under no pressure to buy anything. That way, the buyer can take its time and wait for a truly attractive, low-risk opportunity to come along.

Successful, well-managed companies do make acquisitions, but they use them as a tool for pursuing a core business rather than making acquisitions to form the core of their business.

Even at the best-managed companies, not all acquisitions work out well. Some stumble, and others fail miserably. The best companies cut the risk by only making takeovers that complement their strengths. They are willing to get out, even at a loss, when they see an exit as the smart thing to do.

That’s one more reason why we focus on high-quality, well-established companies—whether they are growth or value stocks. They make fewer takeover blunders. When they do make mistakes, they tend to recognize them earlier and cut their losses before they reach catastrophic levels.

Value company vs growth company investing: Invest in growth stocks to gain above-average prospects

By definition, growth stocks are companies that have above-average growth prospects. They are firms whose earnings growth has been above the market average, and is likely to remain above average. It is often the case that they pay small dividends or none at all. Instead, they re-invest their cash flow in the business, to promote their growth.

Although these stocks can be volatile, they often make good long-term investments. They may be well-known stars or quiet gems, but they do share one common attribute—they are growing at a higher-than-average rate within their industry, or within the market as a whole, for years or decades.

Use our three-part Successful Investor approach to make better value and growth investment decisions

Together, growth stocks and value stocks can form a winning combination. A growth stock can be a top performer while the company is growing. However, a single quarter of bad earnings can send it into a deep, though often temporary, slide. Value stocks can test your patience by moving sluggishly for months, if not years. But they can make up for it by rising sharply when investors discover their true value.

Whether picking value or growth stocks, we recommend that you follow our three-part philosophy.

1. Invest mainly in well-established, dividend-paying stocks;
2. Spread your portfolio out across most if not all of the five main economic sectors;
3. Downplay or avoid stocks in the broker/media limelight.

How do you feel about the volatility of growth stocks? Do you limit the growth stocks in your portfolio?