Distressed Investing Vs. Growth Investing: Which Is Better For You?

investIn investing, there are many strategies and school of thoughts out there. Which might be better for you?

Let’s take a closer look at two popular styles of investing – distressed investing and growth investing – in a bid to answer the previous question.

Distressed investing

Distressed investing is a form of investing in which its adherents focus on looking for companies that are currently facing huge challenges.

The rational for investing in troubled companies is this: Such companies often carry very low valuations because the market’s fearful, but this sets the ground for great investing returns going forward if those companies can bring their businesses back to life and turn things around.

Distressed investing also works on the principle of mean reversion (i.e. most things can’t stay too good forever, just as most things can’t remain hopeless forever) with a view that most businesses operate in cycles; investors of such a style would buy a company at its low point and then sell once the company reverts to a ‘normal’ phase of its business cycle.

There’s an important risk involved with this type of investing though: Companies facing structural declines in their businesses might sometimes be misunderstood as one that’s facing a cyclical decline. Companies confronting a structural decline – an extreme example would be horse carriage manufacturers during the dawn of the era of automobiles – would have almost no way of pulling its business back to its old glory days and investors who mistakenly invest in one would be in for a rough time.

Companies that might be candidates for distressed investing – based on the fact that their profits have declined by huge amounts over the past few years – include Tiger Airways Holding (SGX: J7X) and Neptune Orient Lines (SGX: N03). The former’s a low-cost carrier while the latter’s a shipping firm.

Tiger Airways Holding
Profit for financial year ended 31 March 2011 Profit for FY ended 31 March 2014
S$39.9 million -S$223 million
Neptune Orient Lines
Profit for FY ended 31 December 2010 Profit for last 12 months
US$461 million -US$250 million

Source: S&P Capital IQ

Famous investors in this field include Howard Marks of Oaktree Capital and to a lesser extent, Benjamin Graham.

Growth investing

Growth investing on the other hand is the strategy of spotting companies that would grow much faster than the economy and then investing in them.

The idea is to stay invested for the long-term with such companies throughout their fast growing period. Companies such as Super Group (SGX: S10) and Sarine Technologies (SGX: U77) can be considered as growth companies given their growth rates over the past decade; between 2003 and 2013, the two companies’ profits have grown at a compounded annual rate of 24.5% and 16.3% respectively.

Of course, there would be risks involved with any type of investing and growth investing is no different. The most important risk here is a high-growth company’s ability (or inability) to sustain its growth. Fast-growing companies often trade at a high valuation premium compared to the rest of the market due to various market participants’ high expectations for future growth. But, once growth starts to slow or even reverse, the shares of such companies are often taken to the woodshed.

A good case in point would be Super Group. The instant coffee maker hit a split-adjusted high of S$2.525 last August and at that price, was valued at almost 30 times its trailing earnings. With its past few quarters being less than ideal with a decrease in earnings, its shares have fallen by more than 40% to S$1.48 currently.

Well-known investors in this area of the market include Philip Fisher and Peter Lynch.

Foolish Summary

So which is better for you? Truth be told, comparing different strategies in investing is like comparing different styles of martial arts. There isn’t a style that is superior to all others; it all depends on the practitioner. As such, it is important for you to follow a style that you are comfortable with, and not just copy another successful investor blindly.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore contributor Stanley Lim doesn’t own shares in any companies mentioned.