Value or Growth Stocks: Which Is Better?

What is Value Investing?

One of the long-term strategies to owning a percentage of a company is value investing. In this video, you’ll learn a simple way to understand this concept through an easy and brief explanation. The definition is a strategy that picks stocks that appear to be trading for less than their intrinsic or book value. By knowing the true value of an underestimated stock, you know when to buy. Under the belief that the market overreacts to good and bad news, investors can find opportunities.

Reviewed by Marguerita ChengFact checked by Ryan EichlerReviewed by Marguerita ChengFact checked by Ryan Eichler

Value vs. Growth Stocks: An Overview

Growth stocks are those of companies that are considered to have the potential to outperform the overall market over time because of their future potential. Value stocks are classified as companies that are currently trading below what they are really worth and will thus provide a superior return. Which category is better? The comparative historical performance of these two sub-sectors yields some surprising results.

Key Takeaways

  • Growth stocks are expected to outperform the overall market over time because of their future potential.
  • Value stocks are thought to trade below what they are really worth.
  • The question of whether a growth or value stock strategy is better must be evaluated in the context of the investor’s time horizon and risk.

Value Stocks

Value stocks are usually larger, more well-established companies that trade below the price that analysts feel the stock is worth, depending upon the financial ratio or benchmark used as a comparison. For example, the book value of a company’s stock may be $25 a share based on the number of shares outstanding divided by the company’s capitalization. Therefore, if it trades for $20 a share at the moment, then many analysts would consider this to be a good value play.

Stocks can become undervalued for many reasons. In some cases, public perception will push the price down, such as if a major figure in the company is caught in a personal scandal or the company does something unethical. But if the company’s financials are still relatively solid, then value-seekers may see this as an ideal entry point, because they figure that the public will soon forget about whatever happened and the price will rise to where it should be.

Value stocks typically trade at a discount to either the price to earnings (P/E), book value, or cash flow ratios. Of course, neither outlook is always correct, which means some stocks can be classified as a blend of these two categories. As such, they are considered to be undervalued but also have some potential above and beyond this. Morningstar classifies all of the equities and equity funds that it ranks into either a growth, value, or blended category.

Growth Stocks

Analysts consider growth stocks to have the potential to outperform either the overall markets or a specific subsegment of them for a period of time. These stocks can be found in small-, mid-, and large-cap sectors and can only retain this status until analysts feel that they have achieved their potential.

Growth companies are considered to have a good chance for considerable expansion over the next few years, either because they have a product or line of products that are expected to sell well or because they appear to be run better than many of their competitors and are thus predicted to gain an edge on them in their market.

Important

Make sure you choose the right investment strategy and stocks that align with your objectives and investment goals.

Value vs. Growth Stocks: Key Differences

The table below highlights some of the key differences that exist between value and growth stocks.

Value Stocks Growth Stocks
Price Undervalued, priced lower than the broader market Overvalued, priced higher than the broader market
Earnings  Low P/E values High earnings growth
Risk Relatively stable with low volatility High risk with more volatility
Dividends High dividend yields Low or no dividend yields

Value vs. Growth: Performance

When it comes to comparing the historical performances of the two respective sub-sectors of stocks, any results that can be seen must be evaluated in terms of time horizon and the amount of volatility and, thus, any risk that was endured to achieve them.

Value stocks are at least theoretically considered to have a lower level of risk and volatility associated with them because they are usually found among larger, more established companies. And even if they don’t return to the target price that analysts or investors predict, they may still offer some capital growth. One other thing to keep in mind is that these stocks also often pay dividends as well.

Growth stocks, meanwhile, usually refrain from paying out dividends. Instead, they reinvest retained earnings back into the company to expand. The probability of loss for investors with growth stocks can also be greater, particularly if the company can’t keep up with growth expectations.

For example, a company with a highly touted new product may indeed see its stock price plummet if the product is a dud or if it has some design flaws that keep it from working properly. Growth stocks, in general, possess the highest potential reward, as well as risk, for investors.

Studies

Although the passage above suggests that growth stocks would post the best numbers over longer periods, the opposite has actually been true.

Many studies point to value investing having outperformed the growth style over long-term periods. But looking at more recent data, value did outperform for the first 10 years of the 2000s, but growth outperformed over the last 10 years. Take note that dividends likely play a key role in helping value outperform over longer periods of time.

Going back to 1926, value had numerous periods of outperformance relative to growth. Again, despite the long-term outperformance, growth has reigned supreme over the last decade. With that, the S&P 500 is made up of roughly 40% of technology stocks.

Consult a financial professional if you’re unsure about what stocks may work well for you and your goals.

Examples of Value and Growth Stocks

Value

Value stocks tend to fall in several key industries that are exposed to areas of the market that are sensitive to economic swings. Keep in mind that these are things that people generally tend to need even when times get tough. They include consumer staples, energy, financials, industrials, and materials. The following are some examples of value stocks that fall in these industries:

  • Berkshire Hathaway (BRK.A/BRK.B)
  • Deere & Company (DE)
  • Cigna Group (CI)
  • Proctor & Gamble (PG)
  • Taiwan Semiconductor (TSM)
  • JPMorgan Chase (JPM)

Growth

As noted above, growth stocks are those of companies that are expected to grow at a more rapid pace than the overall market. As such, they tend to outperform the market. Here are some examples of growth stocks:

What Percent of the S&P 500 Is Growth vs. Value?

The S&P 500 is not broken down into growth and value stocks. However, the two sectors that are often considered growth are technology and consumer discretionary, which make up 41% of the index. Meanwhile, value sectors—financials, industrials, energy, and consumer staples—make up roughly 30% of the index.

What Is an Example of a Value Stock vs. Growth Stock?

An example of a value stock would be a bank, such as JPMorgan Chase (JPM). While key growth is often found in the technology space, such as Google (GOOG). 

Are Growth or Value Funds Better for the Long-Term?

Value has outperformed growth stocks over the longer-term, however, growth has been outperforming for the last 10 years.

The Bottom Line

The decision to invest in growth vs. value stocks is ultimately left to an individual investor’s preference, as well as their personal risk tolerance, investment goals, and time horizon. It should be noted that over shorter periods, the performance of either growth or value will also depend in large part upon the point in the cycle that the market happens to be in.

For example, value stocks tend to outperform during bear markets and economic recessions, while growth stocks tend to excel during bull markets or periods of economic expansion. This factor should, therefore, be taken into account by shorter-term investors or those seeking to time the markets.

Read the original article on Investopedia.

admin