When building an investment portfolio, there are many different strategies you may wish to use. Value investing and growth investing are two classic investing styles used by investors.
Even Wall Street classifies stocks by whether they are growth or value stocks. Many stocks have both of these elements, and to create a well-balanced portfolio, one may choose to have a mix of both.
Still, the majority of investors tend to lean towards one or the other. Let’s talk about value and growth stocks, how they are different, and which style to choose for your portfolio.
Growth and Value stocks at a Glance
Here is a look at Value stocks vs Growth Stocks and their general characteristics:
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What are Value Stocks?
Value investors are looking for those hidden gems in the market. These are low-priced stocks that show promise in the future.
There are many reasons why value stocks might be undervalued. For example, a short-term event like a major figure in the company who’s caught in a personal scandal.
While value stocks are underpriced, value investors believe that the price will rebound in the future. Many value stocks have a low price-to-earnings ratio and high dividends.
Value companies tend to be more well-established organizations. These companies generally don’t have flashy growth outlooks.
Value stocks are companies that have steady and predictable business models. The revenue and earnings over time are modest gains. The price of growth stocks is understated, which makes them attractive to value investors.
For example, the stock price of a value stock might be $20. Value investors may believe that this stock will go back to its book value of $25. It’s not a huge difference, but investors feel more comfortable from past performance that the company will have stable stock prices.
Additionally, these types of stocks tend to provide solid dividends. Especially during bear market conditions, value stocks can provide a predictable stream of income.
Among the most famous value investors is Warren Buffet.
Value Stock Characteristics
- Companies are “on sale”, which means they have a low price relative to their profits
- Have proven and stable business models that generate profits with less risk
- May have limited upside if the actual value is priced correctly
What are Growth Stocks?
Growth investors are looking for those stocks that have better-than-average growth potential. If you’ve seen a financial company that has a disclaimer stating that past performance isn’t indicative of future results, this investing style is the exact opposite.
Unlike in value investing, growth investors are doubling down that a stock is already demonstrating growth and will continue to in the future.
Growth stocks typically are companies that are leaders in their industries.
A growth stock may have an above-average price-to-earnings. Dividend payouts tend to be low, or nonexistent.
With growth investing, you’re buying stocks that are already priced high. The risk is that in the future, an unforeseen event could cause the stock price to fall.
Growth stocks come from small, mid, and large-cap sectors. Analysts remove a growth stock from its status when they feel it’s achieved its full potential.
Growth companies generally experience considerable expansion over the next few years. This is typically due to the company having a product or product line that’s expected to sell well or it has a competitive advantage over others in its sector.
The price-to-earnings or price-to-book-value ratio growth companies tend to have high valuations. The revenue and income growth from these companies are faster than their competitors.
This investment style was developed by Thomas Rowe Price Jr. in the 1930s.
Growth Stock Characteristics
- Appear more expensive due to their relatively high prices
- Higher price-to-sales (P/S) and P/E ratios are expected later because of expectations of high growth in sales and cash flow
- Are riskier due to expectations that these companies will deliver more ambitious plans. Share prices will decline if these plans aren’t effective.
Value Investing vs. Growth Investing: Differences
Growth stocks tend to experience more volatility than other types of companies. Hence, the stock price will fluctuate. Growth investors buy growth stocks to profit from their fast price appreciation instead of income from dividends.
The reason that growth companies experience this rapid growth is commonly due to it developing disruptive technologies or offering products not fault elsewhere.
Value stocks are steady performers throughout changing market conditions. Share prices take time to increase. Value investing is about buying stocks that are “undervalued” or when the market perceives its price to be less than its intrinsic value.
Value Investing vs. Growth Investing: Similarities
Growth and value investing styles have their respective followers. However, there’s still quite a bit of overlap.
In fact, you may find the same stocks in growth and value mutual funds. The distinction between growth and value stocks is fluid.
One example of this is when you look at a stock over its lifetime. The stock may start off as a growth stock, and eventually become a value stock, or the other way around.
Many investors who choose one of these investment styles have similar goals. For example, both a value and growth investor may wish to buy low and sell high. The difference is in how they go about it.
Value investing involves looking for companies that are more established and have a stock price that’s currently lower than it should be. Value stocks are expected to eventually rise to those expectations.
Investors looking for growth stocks want to find companies that have future profit potential and the stock price is expected to rise.
Growth and value stocks have the same destination, just get there differently.
Misconceptions about Value Investing vs. Growth Investing
Oftentimes, the major differences cited between growth and value companies are thought of as their respective industries. Growth stocks are generally in tech or IT sectors, whereas value stocks are often found in the financial sector.
This makes sense as the major financial institutions are generally established players, while tech leaders are relatively new.
More important than your investing style is creating an effective diversification plan. Investing in a company’s business during a market dip is a move toward value. You can turn around and invest in a stock at a higher price because you’re betting on it to have outperformed growth in the near future.
Either of these situations is a bet toward the ability to sell the stock at a higher price in the future.
Are you a Value or Growth Investor?
Investing in either style offers great potential for your portfolio. Your personal financial goals and investing preferences will guide you toward the right style for you.
Why Growth Investing might be appealing
You might be more attracted to growth stocks if the following aspects sound like you:
- Current income in your portfolio is not a concern – Growth stocks typically don’t provide much dividend income. Instead, the money is reinvested into the company to help generate more growth.
- Have confidence that you can choose winners – Many growth stocks fall into the technology sector. There are many companies that are competing with one another. You’ll need to choose tech stocks that will eventually win in these emerging industries while avoiding the losers.
- Have a longer-term outlook – It can take a while for growth stocks to get to their full potential. During that course, they’ll be setbacks and economic conditions may change. You need to be willing to be in it for the long haul to realize earnings growth potential.
- Can handle huge share price changes – Growth stocks are sensitive to changes in the future prospects of the company’s business. So when the company’s prospects rise, the stock price can soar. However, if it disappoints, the price can fall down just as fast.
Why Value Investing might be appealing
Value stocks might be more attractive if you’re an investor that has these characteristics:d
- Like stability in stock prices – The price changes on value stocks aren’t very big in either direction. With stable business conditions, the price volatility of value stocks is generally low.
- Want more immediate payoffs – When a company moves in the right direction, the stock price can quickly rise. It doesn’t happen overnight for value stocks. But if you’re a great value investor, you can spot these companies before others and capitalize on their future potential.
- Prefer having current income in your portfolio – The dividends from value stocks is generally more substantial. These companies don’t have big growth opportunities so they have to attract investors differently. Dividend yields are one way to get other investors interested in their companies.
- Can avoid value traps – Even though a stock looks cheap, there might be a good reason for it. You will need to understand the overall market to know when a company can’t keep up with innovations or has lost its competitive edge.
Value vs. Growth Stocks
When you are looking at long-term performance, the winner between growth vs value stocks isn’t clear. During good economic times, growth stocks will outperform value stocks. However, when the opposite is true, value stocks are more sustainable.
Value vs. Growth Indexes
You can understand how growth and value stocks work in the stock market by looking at the indexes. Growth and value indexes track each group of stocks.
The S&P 500 Growth Index (SPYG) has about 500 stocks from the S&P 500. The stocks with the best three-year growth and revenue and earnings per share make up the composition of this growth index. The S&P 500 Value Index (SPYV) chooses stocks with the best valuations by looking at several major metrics.
Bottom Line: Value Investing vs. Growth Investing
You can have both growth and value stocks as part of your portfolio. There are attractive qualities to them both and they serve the same goal.
A portfolio that is diversified and offers you both is ideal. Many investors fall into both styles, though they may prefer one over the other. Consider aspects like when you plan to retire, the type of investor you are, and the state of the current economy when choosing the right investment style.