now, if we cut the crap and look straight into the framework of Modern Portfolio Theory (MPT), we can safely said that the theory is an optimisation technique used to minimise the risk and return tradeoff.
to do so, the idea of diversification of financial instruments is introduced. that is to said, one should invest in a range of financial products such as bonds, equities, real estate and some hedge funds even go as far as to purchase a contract of a football player in the english premier league to further amplify the effect of risk diversification.
this article will focus on a small part of available financial instruments in the market that is equities. equities in general can be classified into a few type that is
1. large capital versus small capital
2. value versus growth
3. domestic versus foreign
4. emerging versus developed
i believe that the terms itself are self explanatory, so let's just zoom in further and look into the type 2 category (value vs growth) stocks.
in general, value stock is the kind of stocks that is characterised as LOW RATIOS OF MARKET PRICE PER SHARE TO VARIOUS MEASURE OF VALUES, UNDERVALUED AND CYCLICAL while growth stocks are generally in HIGH RATIOS OF MARKET PRICE PER SHARE TO VARIOUS MEASURE OF VALUES, HIGH GROWTH AND NON CYCLICAL in nature.
the recognition of the concept of value and growth stock is important as it serve as a guid to the kind of investment strategy one would pursue. dividing the timeline into a short and long term perspective, we can easily observe that both types of stock outperform one another.
in the short run, growth stock reigns over value stocks as investor focuses much more on the growth prospect of a company and thus growth stocks are able to outperform value stocks. Although it is a short run phenomena, the outperformance can last for years before value stocks outperform growth stocks.
in the long run, the value stock outperforms value stocks mainly on its valuation. As people realise the true value of a firm, there's a tendency for the price level to adjust to its true value and thus outperforming the growth stocks. Researchers have shown that valuation (appreciation of value stock) explains 80% of value stock returns in the long run.
behavioural wise, it seems that investors are dictated with two types of emotional flavours namely fear (risk aversion) and greed (risk taking). value stocks can be seen as risk taking behaviour as it has a low growth-low price characteristic, signalling a potential lack of interest among the investors to hold the stocks. hence investing in such stocks are generally a form of risk taking behaviour.
as for growth stocks, the high price of growth stocks and its growth prospects ensures a "guaranteed return" in the near future. the market interest in them is characterised by a herding behaviour effect, ensuring the stock price to continue to rise above it's intrinsic value. this false sense of security by investor can be seen as a form of risk aversion towards risk in the financial market.
the implication is
1. During good economic climate, value stocks are harder to find as investors would be encouraged to shift gears into taking a greater risk.
2. During bad economic climate, growth stock takes hold as investors become risk averse and value stocks are very easy to find.
this would mean that value investors are more likely to find value stocks during economic crisis than a boom period. explaining why so many investors who pursue a "buy low sell high" strategy would enter the market during a recession.
to do so, the idea of diversification of financial instruments is introduced. that is to said, one should invest in a range of financial products such as bonds, equities, real estate and some hedge funds even go as far as to purchase a contract of a football player in the english premier league to further amplify the effect of risk diversification.
this article will focus on a small part of available financial instruments in the market that is equities. equities in general can be classified into a few type that is
1. large capital versus small capital
2. value versus growth
3. domestic versus foreign
4. emerging versus developed
i believe that the terms itself are self explanatory, so let's just zoom in further and look into the type 2 category (value vs growth) stocks.
in general, value stock is the kind of stocks that is characterised as LOW RATIOS OF MARKET PRICE PER SHARE TO VARIOUS MEASURE OF VALUES, UNDERVALUED AND CYCLICAL while growth stocks are generally in HIGH RATIOS OF MARKET PRICE PER SHARE TO VARIOUS MEASURE OF VALUES, HIGH GROWTH AND NON CYCLICAL in nature.
the recognition of the concept of value and growth stock is important as it serve as a guid to the kind of investment strategy one would pursue. dividing the timeline into a short and long term perspective, we can easily observe that both types of stock outperform one another.
in the short run, growth stock reigns over value stocks as investor focuses much more on the growth prospect of a company and thus growth stocks are able to outperform value stocks. Although it is a short run phenomena, the outperformance can last for years before value stocks outperform growth stocks.
in the long run, the value stock outperforms value stocks mainly on its valuation. As people realise the true value of a firm, there's a tendency for the price level to adjust to its true value and thus outperforming the growth stocks. Researchers have shown that valuation (appreciation of value stock) explains 80% of value stock returns in the long run.
behavioural wise, it seems that investors are dictated with two types of emotional flavours namely fear (risk aversion) and greed (risk taking). value stocks can be seen as risk taking behaviour as it has a low growth-low price characteristic, signalling a potential lack of interest among the investors to hold the stocks. hence investing in such stocks are generally a form of risk taking behaviour.
as for growth stocks, the high price of growth stocks and its growth prospects ensures a "guaranteed return" in the near future. the market interest in them is characterised by a herding behaviour effect, ensuring the stock price to continue to rise above it's intrinsic value. this false sense of security by investor can be seen as a form of risk aversion towards risk in the financial market.
the implication is
1. During good economic climate, value stocks are harder to find as investors would be encouraged to shift gears into taking a greater risk.
2. During bad economic climate, growth stock takes hold as investors become risk averse and value stocks are very easy to find.
this would mean that value investors are more likely to find value stocks during economic crisis than a boom period. explaining why so many investors who pursue a "buy low sell high" strategy would enter the market during a recession.
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