Money strategies ยท Investing

Investing styles: index, value, growth and dividends

Investing strategies are about when you put money in (every month, all at once, after a fall). Investing styles are about what you buy. There are four big families, each with its own idea of what makes a good investment, its own favourite ratios and its own famous investors.

๐Ÿ‘ด In one sentence Index investors buy the whole market, value investors buy bargains, growth investors buy the future, and dividend investors buy a stream of cash.

Two example companies

To compare the styles we'll use two made-up companies, with numbers like the ones you see in our company analyzer:

๐Ÿงผ Steady Soap Co.๐Ÿš€ Rocket Cloud Inc.
BusinessSoap and shampoo, sold for 100 yearsSoftware for online shops, founded 8 years ago
Share price$48$120
Earnings per share (EPS)$4.00$2.00
P/E = price รท EPS1260
Expected profit growth3% a year30% a year
Dividend per share$1.92$0 (all profit is reinvested)
Dividend yield = dividend รท price4.0%0%

1. Index investing: buy the whole haystack

Instead of looking for the needle, buy the haystack. An index fund or ETF simply owns every company in an index (the S&P 500, or a global index of thousands of companies), in proportion to their size. It owns both Steady Soap and Rocket Cloud. The idea was made popular by John Bogle, who launched the first index fund for private investors at Vanguard in 1976.

Why it works: after fees, most professionals do not beat the index. S&P's SPIVA reports regularly find that close to 9 out of 10 actively managed US large-company funds trailed the S&P 500 over 15 years. An index fund cannot beat the market, but it is guaranteed to get almost exactly the market's return, for a fee often below 0.2% a year.

๐Ÿ‘ Pros

Very cheap; instantly diversified; no research needed; beats most professionals over long periods.

๐Ÿ‘Ž Cons

You also own the overpriced companies; never beats the market; falls with the market in every crash.

2. Value investing: buy a dollar for 70 cents

Value investors look for good companies whose shares are cheap compared with what the business is worth. Benjamin Graham wrote the rules in Security Analysis (1934) and The Intelligent Investor (1949); his student Warren Buffett made them famous. Graham's key idea is the margin of safety: only buy when the price is well below your estimate of value, so that even if you are a bit wrong, you don't lose much.

The tools are the ones in this course: a low P/E, P/B or EV/EBITDA, a high free cash flow yield, low debt (see ratios) and a DCF value above the price. Steady Soap, at 12 times earnings, is the kind of share a value investor looks at.

๐Ÿ‘ Pros

You pay little, so expectations are low; over many decades value shares have often done better than expensive ones; a clear, logical method.

๐Ÿ‘Ž Cons

"Value traps": some shares are cheap because the business is dying; value can lag for years (it trailed growth for most of the 2010s); needs patience and research.

3. Growth investing: buy tomorrow's giants

Growth investors look for companies whose sales and profits grow much faster than the economy, and accept a high P/E today because profits will be much larger later. Philip Fisher (Common Stocks and Uncommon Profits, 1958) and Peter Lynch, who ran Fidelity's Magellan fund, are famous examples. Rocket Cloud is a growth share.

A useful check is the PEG ratio, which compares the P/E with the growth rate:

PEG = P/E รท expected yearly profit growth (in %)

Steady Soap: 12 รท 3 = 4.0. Rocket Cloud: 60 รท 30 = 2.0. Surprise: adjusted for growth, the "expensive" share looks cheaper, if the 30% growth really happens. Peter Lynch suggested a PEG around 1 or below as attractive. The big risk is the "if": growth forecasts are often too optimistic, and when growth slows, high-P/E shares can fall 50% or more.

๐Ÿ‘ Pros

The biggest winners of the last decades (Apple, Microsoft, Amazon) were growth shares; profits compound inside the company.

๐Ÿ‘Ž Cons

You pay today for profits that may never come; very sensitive to interest rates (growth shares fell hard in 2022); bubbles, like the dot-com crash of 2000โ€“2002.

4. Dividend investing: get paid to wait

Dividend investors buy companies that pay a steady, growing dividend: part of the profit paid out in cash, usually every quarter. Steady Soap pays $1.92 on a $48 share: a 4% yield. Many look for "Dividend Aristocrats": S&P 500 companies that have raised their dividend every year for at least 25 years in a row.

Two ratios matter most:

๐Ÿ’ก A dividend is not free money When a dividend is paid, the share price usually falls by about the same amount on the "ex-dividend" day: the cash moved from the company to you. What matters is the total return (price change + dividends), not the dividend alone. Try the dividend calculator.

๐Ÿ‘ Pros

Regular cash income, useful in retirement; growing dividends are a sign of a healthy, disciplined business; easy to stick with in crashes.

๐Ÿ‘Ž Cons

Concentrated in mature sectors (utilities, banks, consumer goods); dividends may be taxed every year; chasing high yields leads to traps.

The four styles side by side

StyleLooks forKey ratiosEffortMain risk
IndexThe whole marketFund fee (TER), trackingVery lowMarket crashes
ValueCheap, solid companiesP/E, P/B, EV/EBITDA, DCFHighValue traps, long waits
GrowthFast-growing companiesRevenue growth, PEG, marginsHighPaying too much, growth slowing
DividendReliable, rising payoutsYield, payout ratio, FCFMediumDividend cuts, too few sectors

You don't have to pick only one

Value and growth take turns: growth led in the 1990s and the 2010s, value in the early 2000s and in 2022. Nobody knows which will lead next. A common approach is core and satellite: a core of 80โ€“90% in a global index fund (which already holds value, growth and dividend companies), and a small satellite where you practise the style you enjoy, using the company analyzer to check the numbers.

โœ๏ธ Check yourself: A share costs $60, earns $3 per share, pays a $2.70 dividend and is expected to grow profits by 5% a year. Work out its P/E, PEG, yield and payout ratio. Which style would like it?
Show the answer

P/E = 60 รท 3 = 20. PEG = 20 รท 5 = 4 (expensive for a growth investor). Yield = 2.70 รท 60 = 4.5%. Payout ratio = 2.70 รท 3 = 90%. A dividend investor would like the yield, but a 90% payout leaves little room: if profits drop, the dividend may be cut. Check the free cash flow and debt before buying.