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.

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:

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.

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.

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:

Steady Soap: 12 ÷ 3 = 4.0. Rocket Cloud: 60 ÷ 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.

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:

• Dividend yield = dividend per share ÷ price. Very high yields (8%+) are often a warning: the price fell because investors expect a cut.
• Payout ratio = dividends ÷ net income. Steady Soap pays 1.92 ÷ 4.00 = 48% of its profit. Above about 80% for most companies, there is little room if profits fall.

The four styles side by side

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 80–90% 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.