GMO: The Value Versus Growth Dilemma |
1. What is value investing? What is its rationale? What are GMO’s main arguments in favor of value investing?
Value investing is a way of investing in company stocks that are considered either undervalued or out-of-favor by the market. In other word, a value investment is one where the intrinsic value of the stock is not accurately reflected in the current market valuation. The underlying reason of too much decreasing in the stock price is that the company may be losing market shares or even in trouble due to market’s panic attributed to negative rumors as well as having management problems. Since the market price has dramatically descended, ...view middle of the document...
e. chemicals, consumer products | -Internet and emerging technology |
Dividend Policy | -Pay out dividend to shareholders in profitable period | -100% plowback to reinvest in the business |
Book-to-market ratio | -High | -Low |
Price-to-earnings ratio | -Low | -High |
Merits | -Investors can avoid overpay for speculation on the stock price. Value investors have lower cost to acquiring stocks than growth investors | - Although the price for obtaining these stocks is high, the expected growth is higher compared to valued stocks |
3. Should GMO change its strategy now that the world has seemingly turned against it?
We propose that GMO buy some growth stocks such as technology stock and establish a new growth fund or a value-growth fund. By providing his customers an option to switch to growth stock fund during this growth stock leadership market environment, Mayo can lower the risk that his clients will switch out to other investment company. As a result, he will increase his retention rate, retain revenue, and also provide an opportunity for new investors to invest in the “trendy” growth stock fund. In addition, if GMO invest in growth stocks, it will increase the diversification of the overall portfolios; which is that when value stocks are doing well, it will help offset the growth stocks that are performing poorly and vice versa. Most importantly, GMO must provide adequate knowledge of growth stocks investing to its clients before allowing them to invest in them. This will prevent future problems, such as clients complaining about major losses if growth stock crashes one day.
4. Why wouldn’t GMO include Cisco Systems, an otherwise excellent company, in its portfolio at this time? Why is it willing to consider CVS or R.R Donnelley? What are the long-term expected returns for those stocks? Support your answers by examining P/E ratios, price-earnings growth (PEG), and other metrics that may be relevant to the decision.
According to the calculations below in Table 1, we analyze each company with the Book-Market (B/M) ratio, Price-Earnings ratio (P/E), Earning per Share (EPS) growth rate and a projected EPS for year 2003 and 2005 using the LT EPS growth rate.
Table 1: Ratio Analysis – Cisco, CVS, R.R., Manor, S&P 500
Stock(year 2000E) | B/M ratios | P/E ratios | EPS | LT EPS Growth Rate | 2003 LT EPS | 2005 LT EPS |
Cisco (CSCO) | 5.01132.06=0.038 | 132.061.17=112.87 | 1.17 | 30% | 1.17×1.303=2.57 | 1.17×1.35=4.34 |
CVS Corporation | 9.4628.00=0.34 | 28.001.80=15.56 | 1.80 | 17% |...