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Strategy Lab is MSN Money's stock-picking challenge. To learn more about the game and the contenders, click here.
"Growth" versus "value." Ever since those two descriptors were coined decades ago, investors have pitted them against one another.
You may have been asked, for example, "Are you a growth investor or a value investor?" Or you've probably seen articles titled something like "Growth or value: Which is better over the long haul?"
These questions are starting points for some good debates and analyses. But they're also a bit misleading in their simplicity. Many of the most successful investors have used strategies that are neither purely growth-oriented nor purely value-oriented. Instead, they've used growth strategies that incorporate some value characteristics or value strategies that incorporate some growth characteristics.
One excellent example of this is mutual fund great Martin Zweig, whose approach is the basis of one of the five "guru strategies" I'm using in Strategy Lab. On the surface, Zweig may look like as much of a growth investor as there is. The strategy he laid out in his 1986 best-seller, "Winning on Wall Street" -- the book that is the basis for my Zweig model -- examined earnings from a variety of angles, checking to see whether a company's earnings had shown persistence over the long term, trended upward over the past year or two and accelerated in recent quarters.
In all, nine of the 13 variables in my Zweig-based model involve earnings power or earnings growth.
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But for all his focus on growth, the strategy Zweig detailed in his book also incorporated a key value element: He wanted stocks with price-earnings ratios no greater than three times the market average and no greater than 43 regardless of what the market average was. Such high-P/E stocks involved too much risk, he believed, so he avoided them, even if their earnings growth was exceptional.
Zweig also looked at the debt-equity ratio, another variable more often associated with value investing. Recognizing that different industries carry different amounts of debt, Zweig looked for stocks with debt-equity ratios lower than their industry average.
By incorporating value aspects into his growth approach, Zweig made sure he wasn't getting fast-growing stocks that were overpriced -- and that weren't simply using leverage to generate attractive earnings numbers. And just as this approach worked for Zweig, it's worked for me, too. In the almost five years that I've been tracking it on Validea.com, a 10-stock portfolio of stocks scoring highest on my Zweig approach has gained 121.9%, more than four times the S&P 500 Index's ($INX) 27.3% gain during that time.
In addition, for a growth-focused strategy, the portfolio hasn't been overly volatile, with a beta of 1.24. Given that stellar track record, I thought it would be good to demonstrate just how this growth-value hybrid strategy works, using a couple of my portfolio's current holdings:
Fastenal (FAST, news, msgs). Based in Minnesota, Fastenal is the largest fastener distributor in the U.S. It makes a variety of industrial supplies and tools, ranging from cutting tools and abrasives to hydraulics and pneumatics to chemicals and paints. The company has 12 distribution centers in the U.S. and more than 2,160 stores. It has a market capitalization of $6.7 billion.
Though Fastenal's business might not be the most exciting, the company has been generating just the kind of strong earnings history my Zweig-based model likes to see. The firm's earnings per share for the current quarter (46 cents) is positive, for one thing, and its EPS growth rate for the quarter (27.78% compared with the same quarter a year ago) is also positive, another good sign.
In addition, Fastenal's growth rate for the current quarter is greater than its EPS growth rate for the past three quarters (19%, compared with the same three quarters a year earlier). That shows that earnings aren't just increasing; their growth is accelerating, which my Zweig-based model likes.
Zweig also looked at long-term earnings, and one way my Zweig-based model does this is by making sure a firm's EPS have grown in each year of the past five. Fastenal's EPS for the past five years have been 55 cents, 86 cents, $1.10, $1.32 and, most recently, $1.54, passing this test.
As you can see, when it comes to growth, Fastenal rates quite high. But now it's time for the Zweig strategy's value check. Remember, Zweig didn't like firms whose P/E ratios were more than three times the market average, or greater than 43 regardless of the market average, because they were too risky. Currently, Fastenal's P/E is 27.31, while the market P/E is 16. That passes the test, indicating that the stock is still a good buy.
In addition, Fastenal scores well -- extremely well, in fact -- on my Zweig-based model's other value-type test, the debt-equity ratio. While its industry (miscellaneous fabricated products) has an average debt-equity ratio of 78.96%, Fastenal has no debt, passing this test with flying colors.
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