Deciding whether to take a value or growth approach to investing is undoubtedly one of the most important decisions an equity investor can make after deciding on an appropriate asset allocation strategy. How should you decide on your strategy? First, make sure you understand the basic differences between value and growth investing.

Buy Low, Sell High
Value investing operates on the principal of buying stocks that are out of favor and relatively inexpensive and then waiting for them to rebound. In order to identify these companies, value managers look for a fundamentally strong company whose stock price is valued lower than that of the market, its industry peers and its historical average valuation. If the share price does not reflect the entire worth of the company (and the investor deems it capable of overcoming current obstacles) it would be considered undervalued and therefore could present a buying opportunity. Value companies tend to have relatively low price/earnings ratios, pay higher dividends and have historically more stable stock prices.

Buy High, Sell Higher
If "buy low, sell high" is value investing's mantra, then "buy high, sell higher" is that of growth investing. Growth investing suggests that you can't go wrong buying stocks of rapidly growing companies, no matter how high their prices become relative to profits and asset value. Growth managers look for stocks with faster-than-average gains in earnings or sales, and areas in which the current trend is expected to continue. This often means buying stocks that are already pricey and sometimes even requires quick turnover of portfolio holdings in order to make room for the next high-growth stock.

Value Wins Out
There is merit to both schools of thought, but, in the long run, it is undeniable that the facts and figures tend to favor value. With less risk and a stronger performance record, value investing has a number of notable factors helping to tip the scale in its favor.

One reason is the theory that extremes trend toward an average. Viewed as one of the most powerful forces in investing, "reversion to the mean" simply refers to the tendency for very high returns to erode over time. The theory suggests that it is almost impossible for high-flying stocks to sustain their growth and that eventually they will revert back to normal levels of business performance and profitability. The theory also works in the opposite direction, saying that companies that experience lower than average returns due to temporary circumstances such as an unexpected plant outage or strike eventually return to their normal levels of profitability.

Another factor that weighs in favor of value versus growth is investors' expectations. "Growth stocks trade at valuations that have extremely high expectations built into them," states Jennifer Rosenblum, senior vice president, Investment Advisory. With no room for error, the stocks are hit hard if growth companies disappoint.

Value stocks, on the other hand, trade at levels that have much lower expectation built in. "This leaves a lot of upside room when the company delivers results better than expectations," Jennifer explains. "Also, value stocks tend to not get hit as hard as growth stocks when they have disappointing results since the expectations were fairly low to begin with."

Finally, another challenge for growth investing is that no one can predict which sectors will represent growth in the future. Growth managers not only have to predict the next "hot" growth sector, but they then need to identify those companies within the sector that will dominate.

A Balanced Approach
"Too often investors flee a particular investment style because it is not 'in vogue' that year and then end up missing out on its recovery," said Jeffrey Schvimer, senior vice president, Equity Management. "Investors need to understand that there is room in their portfolios for both value and growth investments."

Robert Weil, senior vice president, Investment Advisory, agrees: "I think it is wise for investors to have a combination of both growth and value represented in their portfolios. It is important however for investors to understand the basic difference between the two styles so they can form realistic expectations about how the various components of their portfolios are likely to perform under different market conditions. Armed with this knowledge, an investor can better determine when and why to stick with a particular sector that may be temporarily out of favor."