Growth Vs. Value

Crossing Wall Street makes a good point about tech giants Microsoft and Dell this week:

In less than a decade, Dell and Microsoft have gone from growth stocks to value stocks.

Shares of MSFT are getting ripped today (Friday) in the wake of the company's third-quarter earnings report. The company earned 28.6 cents a share, which rounds up to 29 cents, but that includes a 2.6-cent charge for stock options. The Street consensus was for 33 cents a share.

The stock is currently down over 11%, its worst day since 2000. As bad as Microsoft is, Dell just don't make no sense. The stock is down to $26 a share! One of the things I've learned about investing is that trends can go on longer than you think. Everytime you wonder, "how much more can this go on?" it will.

Dell was at this price eight years ago, yet the company's sales and income have tripled since then.

Generally, when there is more gowth in the market than value, this is what constitutes a bull market, and when there's more value than growth lying around, it's a bear market. A healthy market is a balance between growth and value, and so is a healthy company: it's a sign of a solid organisation when it makes it past the growth stage and into the value stage, since growth usually comes at a cost which investors end up overpaying for. The real challenge for organisations like Dell and Microsoft now is to create innovation in microcosms of their value chain and benefit from a variety of offshoots of growth without compromising on the core assets of the business which make them so competitively resistant to the short-term market trading cycles their younger growth siblings can't weather.

The same is going to be the case for markets in the Far East, where growth is outstripping value right now at an unprecedented pace. If the asset-rich  companies of say, the Shanghai stock exchange can somehow find a way to become innovative at the right price in the right areas of their value chains while the going is still hot, this would prevent the Chinese economy from the fast overheating it's currently experiencing.

This is easier said than done, however. The twist that makes the transition from growth to fair value so hard is that just when value companies are being pummeled by an exuberant short-term trading mentality, growth companies are usually being rewarded with massive valuations. What this ultimately means is that either value companies end up over-paying for the price of intellectual capital and innovation, or they end up short of the whole venture altogether and stuck with traditional value chains which keep them in the same rut they got themselves into in  the first place.

A possible way out of this vicious cycle remains yet to be proven in oil and energy companies.  Oil stocks have been rewarded hansomely for their increases in profits due to the high oil price over the past 18 - 24 months; if as a result of this capital injection they can show that they are funding and developing alternative solutions for newer, cleaner energy sources and capitalise on that investment once the price of the black liquid shrinks again, this will be a very positive example for large organisations to follow. It may, in fact, be the first time in history where organisations have successfully taken advantage of the disruption happening to their own traditional business models by siezing and taking control of it first.

The process requires leaving some cash on the table, and this is difficult for institutions like Microsoft and Dell, who still think of themselves as growth companies, to do. But ultimately, it's cash on the table or cash in a new entrant's pocket, or worst of all, a giant macro-level cash exodus - as Bill Gates knows only too well, and as many entrepreneurs in the currently growth rich Far Eastern economies are about to find out.