What is “Growth Vs. Value Investing”?
“Growth” and “Value” are two fundamental approaches to investing that offer investors different ways to generate returns. Value investing tends to focus on companies that are currently trading below their intrinsic value as a result of negative sentiment trade or experiencing earnings pressure. They offer value investors the potential to recover their stock price and deliver higher returns than the market average. On the other hand, growth stocks provide exposure to companies with high growth potential where investors are prepared to pay a higher perceived price to enjoy the expected benefits of their prospective earnings. Although the two styles are very different, often investors blend them in order to achieve optimal diversification and manage the overall risk in a portfolio.
Key Learning Points
- The concept of growth vs. value investing requires fundamental stock analysis and determining both the stocks fair price and upside potential
- Growth stocks offer investors the potential to outperform the broader market as a result of higher projected future earnings
- Value stocks are companies experiencing disruption in their revenue or profit streams for a particular reason and are trading below fair value, so investors can participate in a potential share price recovery
- Both growth and value stocks could offer attractive opportunities to investors, but blending them together may deliver optimal risk-adjusted returns
Growth investors tend to prefer companies with a solid track record of growing earnings. They view these stocks as having the future potential to sustain this growth rate higher than the market over the long-term. Growth companies usually tend to be disruptive businesses that operate in a growing industry, for example technology, or possess intellectual property, patent on a service or product, or strong brand recognition. As a result, growth stocks are typically more expensive than the wider market, but investors are prepared to pay for this: they want to gain exposure to their projected future earnings and prospective rise in stock price.
Some of the shared characteristics in growth stocks is that they tend to show higher valuations, for example on a price to earnings (P/E) or price to book basis. Growth companies are unlikely to pay dividends as they typically retain all (or the majority of) profits and invest them back into the business in the form of product or service development, research and improvement of business lines. Growth stocks tend to be more volatile and therefore are more suitable for investors with higher risk tolerance. In addition, smaller companies are naturally expected to grow at a faster rate than their large cap peers.
Value stocks are businesses that are currently underappreciated by the market and trade below their fair value. That could be a result of many reasons such as short-term disruption in profits to which the market overreacted, or company assets that might not be reflected in its share price, for example property. The idea of investing in such companies is that the market will soon recognize the company’s value and its share price will improve. Value businesses do not have the growth potential of their growth peers, but offer attractive entry points for investors due to relatively lower valuations and recent share price underperformance.
Value companies share characteristics such as lower price to earnings (P/E) and higher dividend yield ratios. Usually, their share price does not appreciate at high rates, but these companies also tend to distribute their profits to shareholders in the form of dividends. Therefore, value investing can be suitable for investors with higher income requirements. In addition, due to their limited upside potential, value companies tend to be more established and mature sectors and marketplaces, and thus tend to be less volatile than the overall market.