Value Stock Versus Growth Stock - Essay Example

In real world, there are more risks involved than just one of type of risk. Market sensitivity is an important risk but that cannot alone be used in order to compute the intrinsic value of stocks and hence by relying on only this type of risk, we are actually making the things more simple than they really are and not accounting for important risk elements which lead to faulty analysis and intrinsic value determination of stocks. This can lead to poor decision making and by relying just on Capital Asset Pricing model, investors stand a chance of losing their hard earned money because they are not account for all types of risk that should be included in their investment.

All of this debate shows that investors should not just pick the blue chip stock but also first try to classify stocks into value or growth stocks and then create a portfolio on the basis of a strategy called “Dogs of the Dow” and keep on making structural changes to their portfolios based on the results announce. This way they are not only diversifying, but also upgrading the return on their investments. 2) There are several factors that account for Risk and Returns according French and Fama.

Risks are basically of three types. The first type of risk is beta or market volatility. The second type of risk is investing in small versus big stocks, and the final type of risk is investing in growth versus value stocks. The reason why these factors are considered is because these are three main alternatives investment strategies that an investor can choose. Investor can invest either in stocks which have high beta or low beta. However, this decision will be made according to the expectation of the investor.

If the investor is expecting the market to fall then negative correlation with market in a stock would be preferred. However, if the investor thinks that the market is going to climb upwards then it is better for the investor to invest in stock having a positive correlation with the market. In either case, the investor is speculating market to perform either way. If the investor chooses to invest in large company, then there are chances that the growth of these stocks would be much less than a new aggressive company.

Hence, the investor would not be able to make quick capital gain in these stocks, but stream of income in the form of dividends would be quite high if the investor chooses to invest in a stock of a large company. Similarly, if the investor chooses to invest in the value stock there are chances that the investor would earn high returns, but there are also chances that the investor would not be able to earn any return on these stock. This is in line with Warren Buffets’s and EMH investment theories which state “Buy the sells and sell the buys” .

The fundamental behind this theory is the fact that stocks which have never performed in the past will perform in the future whereas stocks which have performed well in the past will not be performing as brilliantly as they have done before. Hence, it is better to buy stocks of companies which are relatively lagging behind the blue chip stocks. In other words it is better to buy the dogs of today than stars of the past. 3) Capital Assets pricing model is based on just one facet of the risk return model.

This risk is represented by beta and can be explained as stock