Growth investing and value investing are two different styles of approaching stocks. They involve similar types of fundamental stock analysis, but require different investment mindsets. Growth and value investing can generate very different returns under different market conditions.
So, which style of investing is right for you? We’ll compare which is better: growth or value investing to help you decide. Let’s dive in!
What is Growth Investing?
Growth investing involves investing in “growth” stocks. These are stocks that are expected to outperform the broader market because of fast revenue and earnings growth.
Growth stocks are often young companies with a lot of room to attract new customers or monetize their products. However, established companies – particularly in the tech sector – can be considered growth stocks if they introduce new product lines or move into new markets.
What is Value Investing?
Value investing involves investing in “value” stocks. Value stocks are undervalued based on what investors expect based on a company’s financials. Often, value stocks have lagged the broader market and may even have seen their stock prices fall in the recent past.
Value stocks are typically well-established companies with strong financials, experienced leadership teams, and proven products and markets. They may be flagging because of a disappointing earnings report or negative media coverage, but the underlying business remains intact.
Growth and Value Investing: Similarities
Growth and value investing are similar in that they have the same goal: to find stocks that are priced lower today than what investors believe they will be worth in the future. Both investing styles aim to generate market-beating returns by picking individual stocks.
In addition, growth and value investing are both types of fundamental investing. Both growth and value investors need to carefully evaluate a company’s business, including everything from cash flow and profits to customer growth and competition. The more investors know about a business, the better they can evaluate its potential for future growth or the stock price it should earn.
Growth and Value Investing: Differences
There are several key differences between growth and value investing.
The first and most important is what growth and value investors look for in stocks. Growth investors look for companies that are poised to rapidly grow their earnings. Often, growth investors are willing to overlook current unprofitability, especially if a company is unprofitable because it’s investing in future growth.
Value investors, on the other hand, would almost never consider a company that has never turned a profit. Instead, they look for stocks that are simply priced lower than they should be based on fundamental analysis. Value investing revolves around proven, reliable businesses that can beat market expectations; however, low those expectations may be.
Growth and value stocks also diverge significantly in how they’re valued. Growth stocks are typically priced at a premium, with high price-to-earnings or price-to-book ratios. Value stocks, on the other hand, may have price-to-earnings ratios that are lower than peers within their industry.
Finally, growth and value stocks differ in how risky they are. Since growth stocks’ premium valuations depend heavily on companies meeting aggressive growth targets, these stocks can be volatile. One bad earnings report can send a growth stock tumbling. Value stocks tend to be more stable in price, and many pay dividends that can help mitigate stock price depreciation.
Which is Better: Growth or Value Investing?
There’s no definitive answer as to whether growth or value investing is better. Long-term studies that have compared the two investing styles have found that, in the long run, they produce nearly identical returns. Under some market conditions, value stocks perform better; under others, growth stocks perform better.
So, choosing between growth and value investing comes down to a few different factors. The first is your preference as an investor. If the volatility and excitement of new, fast-growing companies appeals to you, then try growth investing. If you prefer investing in proven companies and experienced management teams, then try value investing.
Your investment timeframe can also play a role in which investing style is better. Growth stocks can be more suitable for shorter investment horizons from 1-3 years since this is how long it takes many companies to prove their business model and expand into new markets. Value stocks, on the other hand, can serve as longer-term investments. Even after these companies reach your price target, their stable business and slow but steady growth makes them suitable to hold in your portfolio for years.
Finally, it’s worth thinking about what type of investing the market favors right now. During bullish periods, investors’ tolerance for risk increases, and growth stocks often benefit. Under more turbulent market conditions, growth stocks may suffer as investors seek safe-havens. But value stocks tend to retain their value and may even rise while the rest of the market falls.
Combining Growth and Value Investing
Importantly, you don’t have to choose between growth and value investing – you can do both. In fact, since growth and value investing involve many of the same fundamental analysis tools and techniques, you can apply the same toolbox to both types of stocks. Investing in a mix of growth and value stocks in your portfolio can be especially effective since these stocks tend to outperform under different market conditions.
Conclusion: Growth vs. Value Investing
Growth and value investing are styles of fundamental investing with two very different goals. Growth investing targets young companies with rapidly rising earnings, while value investing targets established companies that have lagged behind their industry peers and are in the process of a turnaround. Ultimately, neither style is definitively better than the other, and investors can use growth and value investing in combination to get the benefits of both approaches.