Growth vs Value Investing: What's the difference?
During different periods of time, the stock market appears to favor one of two stock categories - growth stocks or value stocks. As an example, since the market bottomed out in 2009 as a result of the sub-prime crisis, growth stocks have outperformed their value counterparts. Some investors are speculating that value stocks could make a comeback due in part to big changes caused by the pandemic and to the fact that the growth cycle will eventually have to come to an end. As well reasoned as these arguments may seem, they, of course, do not guarantee future performance.
When watching what is happening in the markets and observing the tug-o-war between these two classes of stocks, it’s important to know what the difference is between value and growth.
What Is Growth Investing?
Growth investing essentially uses today’s information to identify tomorrow’s strongest performers. The goal is to identify the “winners” - stocks of companies within industries that are expected to experience significant growth.
Growth investors seek companies that are positioned to generate revenues or earnings greater than what the market expects. When growth investors find a promising stock, they buy it, even if it has already experienced rapid price appreciation. They hope that the price will continue to rise as the company grows, word gets out and more investors buy in.
Growth investors are more concerned about whether a company is demonstrating behavior that suggests it will be one of tomorrow’s leaders. They often times look to invest in younger companies whose earnings and performance are expected to outperform companies in their industry sector and the market in general. They are less focused on the underlying, intrinsic value of the company.
For example, growth investors may prefer companies with a sustainable competitive advantage in their industries that are expected to experience rapid revenue growth, that are effective at containing cost and that have an experienced management team in place.
Risks of Growth Investing
Growth investments may have a higher price-to-earnings ratio (PE ratio) than their counterparts, and they may in some cases be prone to higher volatility as well. Growth stocks may also be highly speculative in nature. These investments are typically bought at an already high price, and there’s always a risk that the price will fall or cease to rise any further.
What Is Value Investing?
The idea behind value investing is that investors are bargain hunting. They’re looking for stocks that they believe are undervalued by the market. If they consider a stock to be underpriced, it’s an opportunity to buy. If they consider it overpriced, it’s time to dump it. Once they purchase a stock, value investors hope to ride the price upward as the security returns to its “fair market” price – selling it when this price objective is reached.
Warren Buffet, the quintessential value investor, has a famous quote, “Be fearful when others are greedy. Be greedy when others are fearful.” When investors are afraid, the price of stocks may fall more than the underlying value would dictate. This is when a value investor will be a buyer. (Ironic sidebar: As of the date of this article, Morningstar classifies Berkshire Hathaway, the holding company founded by Buffet, as a “Classic Growth” type stock.)
To determine a value investment, investors may carefully examine the company’s balance sheet, income statement and statement of cash flows to get a clear understand of its assets, liabilities, revenues and expenses.
Risks of Value Investing
There’s no guarantee that a stock will appreciate in value as much as a value investor may anticipate. A stock believed to be undervalued may remain undervalued, or even drop in value.
Key Differences
Value investing and growth investing follow the same general principle - buy low and sell high. While they can often overlap in criteria, the key difference between these two guiding principles is this: value investments have generally already proven their worth, while growth investments show potential for future worth. In other words, both investment types are banking on the assumption that the value will rise, but for fundamentally different reasons.
Summary
So, you may be asking yourself:
Are value stocks safer than growth stocks?
Should I own more growth or value stocks?
As with most questions related to investing, the wholly unsatisfying answer is, “It depends.” When analyzing your investment portfolio, you may find that a combination of both growth and value could provide a healthy and diverse assortment. But as always, consult with your fiduciary investment advisor and perform a comprehensive financial plan before making any decisions regarding your investment portfolio.
About the author:
JP Geisbauer is a Certified Public Accountant and a Certified Financial Planner ®. He is the founder of Centerpoint Financial Management, LLC, a retirement planning, investment management, and tax planning firm located in Irvine, CA.
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Disclaimer:
This article is for general information and educational purposes only. Nothing contained in this article constitutes financial, investment, tax, or legal advice. Before taking any action on any topic discussed in this article, please consult with your financial planner, investment advisor, tax professional, and/or attorney for advice on your specific situation.