Overview
- Growth stocks are typically more volatile and riskier than value stocks
- Value stocks tend to be more stable and less volatile than growth stocks
- To invest in growth or value stocks, you need to consider factors and metrics
Introduction
Growth stocks or value stocks? This question is age-old for investors. At the core, it’s a question of whether you want to bet on the future and invest in companies that have demonstrated growth or whether you want to buy into stable companies that are good values now. The truth is neither one will be right all the time.
Investors who bet on growth stocks get burned when the market crashes. Those who look for value stocks often miss out on gains during bull markets. Still, doing some research can help you answer the question more effectively.
This article details growth vs value investing to help you decide which is suitable. It reveals why you might need either or even both in your portfolio.
What Are Growth Stocks?
Growth stocks are companies expected to grow their earnings faster than the market. These companies often have high price-to-earnings (P/E) ratios, meaning they’re more expensive than other stock investments in their sector. Because of this, investors who want to buy growth stocks must be aware that their investments might be riskier.
If a company has a high price-to-earnings ratio, it means investors think the firm will grow its earnings very quickly. But if not, those same investors could lose money on their investment. Because growth stocks can be riskier than other investments and trade at higher prices, it’s crucial for you as an investor to understand where your money is going.
What Are Value Stocks?
Value stocks are often defined by their low price-to-earnings (P/E) ratio. These stocks tend to be overlooked by investors and analysts, which means they’re also undervalued compared to other stocks within the same sector.
Because value stocks have lower price-to-earnings ratios than growth stocks, they aren’t always great investments if you’re looking for short-term gains. But if you want more stability and predictability over your portfolio’s long-term prospects, these companies can provide an excellent opportunity for growth over time.
Growth Vs. Value: What is the Difference?
| Trait | Growth Stocks | Value Stocks |
| Company Features | High growth potential | Low growth potential |
| Valuation | Based on future earnings | Based on present value |
| Stock Popularity | Higher popularity | Lower popularity |
| Dividends | Pay less often | Pay more often |
| Volatility | More volatile | Less volatile |
| Examples | Amazon | Procter & Gamble |
While growth and value investing are not mutually exclusive, they represent two distinct strategies you can use to maximise returns. By understanding the differences between them, you can determine which approach best fits your investment objectives.
Below are five key differences between growth and value stocks:
Company Features
In terms of company features, growth stocks are companies with high growth potential. They typically have new products, newly acquired businesses, or a more promising market share than other stocks in their industry.
On the other hand, value stocks are companies whose shares are trading at low multiples of earnings and book value per share (in other words: they’re underpriced). These companies tend to be well-established and successful but lack the high-growth potential of growth stocks.
Valuation
The most crucial difference between growth and value stocks is their respective valuations. Growth companies are often valued based on their future earnings potential, which can be difficult to predict.
The valuation basis means growth stocks tend to trade at a premium over their book values (or net asset values). Higher prices for these companies reflect investors’ anticipation that the company will grow faster than other stocks in its sector, resulting in higher profit margins and more market share over time.
Value companies, by contrast, are usually valued based on their present value of assets. These assets are the total worth of tangible things such as land and buildings that make up a company’s operation minus any debt they owe.
Value stocks’ valuation may also include discounted cash flow (DCF). The metric calculates how much money will come into or go out of a business during any given period based on projected revenues minus expenses, including capital investments.
Stock Popularity
Growth stocks have higher popularity than value stocks. When you look at the number of investors following a company, you’ll see that growth stocks are more likely to be followed by investors. This means that if there’s some news about one of your favourite growth companies, you’re more likely to hear about it than if the same news was announced for a value stock.
In addition to being followed by many investors, growth stocks also tend to get more coverage from analysts who follow the broader market and individual companies. You’ll find analyst research reports on almost all popular growth stocks but not so much for value ones unless they’re considered ‘special situations.’
Dividends
With growth stocks, you’re more likely to be looking at companies that don’t often pay dividends. Value stocks, on the other hand, are likely to pay dividends.
Dividends can signify a healthy company, and not all growth stocks are bad or value stocks good. However, some research shows that dividend-paying companies tend to outperform non-dividend firms over time.
Volatility
You can determine stock volatility by how quickly or slowly the price changes over time. A stock with high volatility will experience large swings in its prices, whereas one with low volatility won’t move as much.
Growth stocks are more volatile than value stocks. A growth company may go through wild swings in its stock price for several reasons, such as the launch of a new product or the roll-out of large capital projects at the company.
On the other hand, value stocks tend to have lower volatility than growth stocks. This is because they’re less susceptible to short-term fluctuations and changes in sentiment.
Can A Stock Be Both Growth And Value?
The answer is yes. A stock can be both growth and value. But not at the same time—it’s all about what you’re looking for in an investment.
Growth and value investing are approaches to stock picking, but they have different goals. Growth investors are looking for stocks they think will quickly increase in value. Value investors are looking for stocks they think will increase in value over time.
Thus, growth investors tend to look at things like revenue growth, earnings per share growth, and other metrics that demonstrate a company’s ability to grow its business. Value investors tend to look at things like price-to-earnings ratios and price-to-book ratios.
In some cases, you can find a stock that has both characteristics—that is, growing its earnings quickly and also trading at a low price relative to its earnings or book value. However, this is not always the case. Many factors go into choosing stocks to invest in, including your risk tolerance level and financial goals.
Growth Investing Vs. Value Investing: Which is Better?
The answer depends on your goals as an investor. If you’re looking for long-term growth, growth investing is probably right for you. But if you’re looking for income without sacrificing growth potential, value investing may be your best bet.
The more detailed answer is that both growth and value investing can be profitable—but they each have advantages and disadvantages. Therefore, it’s crucial to ask some questions and consider some metrics before venturing into either or both.
Growth Vs. Value: What Do You Need to Know?
The stock market can be a scary place. It’s full of jargon, and it’s easy to get lost in the weeds. But the goal is simple: buy low, sell high. And if you want to learn how to do that, it helps to ask questions. Here are things to know:
How long will it take you to reach your target?
Growth investors prefer stocks that are growing faster than the market. However, if the growth is too fast and unsustainable, it can be risky. Value investors look for companies the market has overlooked and offer a better price than their peers.
What are your goals?
If you’re looking for long-term growth potential and not concerned about short-term volatility, growth investing may be right for you. If you want more immediate returns with less risk, value investing may be more suitable for you.
How much time do you have available?
Growth investors require more research time than value investors. However, it also offers high rewards in their portfolio over time if done correctly. Value investors require less research time because they’re focusing on companies with low valuations compared to their peers rather than solely focusing on growth metrics.
What type of investor are you?
Are you a long-term investor or an active trader who likes to make quick decisions based on market momentum? It may seem like a simple question, but it’s an important one when determining your investing style.
If you’re the former, growth investing may be better suited for your personality type. But if you prefer the latter, value investing may be more likely to deliver results over time.
How well do you understand investment fundamentals?
If investing is new for you or makes your head spin just thinking about it, maybe it’s best not to invest in growth funds. You’ll eventually do, but wait until after more research has been done on the subject (or at least until you’ve had a chance to talk with a financial advisor).
What Metrics Help Determine Stock Value and Growth?
Ever wonder how to know if a stock is a growth or value stock? It’s a pretty simple equation. All you have to do is figure out the metrics to track. Some of them include:
Earnings growth
If you’re trying to decide whether to invest in growth or value stocks, you’ll want to look at the past earnings growth of the company. Companies with strong earnings growth will be more likely to continue growing their profits, while those without consistent and reliable earnings will stagnate or even lose money.
If your goal is growth investing, look for companies with consistent near-term earnings growth. Ideally, this will be over 20% per year for at least the past three years. For value investors, look for companies with low P/E ratios (ideally under 15) and high dividend yields (ideally over 2%).
Price-to-earnings ratio (P/E)
The price-to-earnings ratio (P/E) is a measure of how much investors are paying for each dollar of a company’s earnings. It’s calculated by dividing the current share price by earnings per share. A P/E of 15 means the stock price is 15 times higher than the company’s earnings per share, so it’d be considered expensive compared to other stocks with lower P/Es.
If you want to use this metric to make your growth or value investing decision, you need to know how its value compares with other companies in your industry and sector. You can do this by looking at industry statistics from market research firms. There are also free online tools that provide average P/Es across multiple industries and sectors.
Price-to-book ratio (P/B)
A company’s price-to-book ratio is calculated by dividing its market capitalisation by its book value, which is the total amount of all assets minus intangible assets and liabilities.
If a company has a high price-to-book ratio relative to other companies in its industry, it likely means investors think it’s going through rapid expansion or has excellent growth potential. On the other hand, if a company has a low price-to-book ratio relative to other companies in its industry, investors likely think it’s slow-moving or poor at adapting to changing market conditions.
Return-on-equity (ROE)
Return on equity (ROE) is a ratio that measures a company’s ability to generate profits from the money invested in it. It’s calculated by dividing the net income by shareholders’ equity, and it can be used as an indicator of whether you should invest in value or growth stock.
Growth stocks are companies that have high expectations for future growth, so they’re expected to have low returns on equity. Value stocks have lower expectations for future growth, so they’re expected to have higher returns on equity.
When you’re trying to decide whether to invest in a growth stock or a value stock, you can look at the current return on equity or use historical data from past performance. If the current ROE is above 15%, it may be worth investing in this company—it has been consistently generating profits and is likely to continue doing so.
Earnings per share are calculated by dividing the company’s annual earnings by the number of outstanding shares. So if a company has 100 million shares and earned $10 million last year, its EPS would be 10 cents ($10 million/100 million).
If you want to invest in growth stocks, look for companies with an EPS growing quickly. This means they’re bringing in more money than they used to and are likely to continue. If you choose to invest in value stocks instead, your goal should be finding a company whose EPS is rising slowly but steadily.
Cash flow from operations (CFO) growth
Cash flow from operations indicates whether a company generates enough cash to support its growth. It’s calculated by subtracting all expenses from the total revenue and then adding any depreciation and amortisation charges.
The higher a company’s cash flow from operations, the better it can invest in new product development and expand its operations, leading to better long-term growth.
Growth Stock Vs. Value Stock: Which Should You Buy?
Value investing and growth investing are fantastic investment strategies. The right one to choose depends on your unique needs as an investor.
Value investors seek out stocks underpriced by the market, whereas growth investors buy stocks based on future earnings potential or momentum. Value investors tend to rely on trends from the past, while growth investors look toward the future.
If you’re looking for short-term gains, focus on value investing. But if you want long-term wealth building and a relatively low-risk way to invest in startups or emerging markets, go with growth investing instead.