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When you dive into the world of investing, one of the first concepts you come across is the growth versus value debate. To define these two styles, or approaches, in a nutshell:
- Growth investors want their holdings to…well, grow
- Value investors want to find stocks that underperform their “true” value and capitalize on their inevitable rise
But there’s a lot more to the debate than that, and an important question to answer. Is growth or value investing better for your portfolio – and how do you know?
>> More: How to Start Investing
What is Value Investing?
In essence, value investors are the bargain hunters of the investment world. They prowl the market for companies they believe are woefully underpriced and snatch them up in spades.
The goal is to hunt down those securities that are due shortly for a reckoning – and when the time comes, they’ll ride the rise all the way up.
But the reasons that a company may be undervalued are subjective and myriad. Legal rulings, economic downturn, and geopolitical events can all weigh down a stock’s performance.
Regardless of the reason, value investors balance the current price against the stock’s underlying fundamentals. They may consider potential indicators of an undervalued stock like:
- A low price-to-earnings ratio
- High dividend yields
- A lower price than its current book value
- High cash flow and robust revenues
Then, an investor will decide whether the stock fits their parameters of a value investment. If they like what they find, they’ll go in – and if not, they’ll head back out on the hunt.
What is Growth Investing?
By contrast, growth investors chase those securities with the highest potential for fast, aggressive gains.
This potential may be due to high market demand for their niche, an exceptional product, or a top-notch management team that exploits advantages in a competitive arena.
When seeking growth stocks, investors may consider a variety of indicators, such as:
- Companies with better-than-expected growth on their balance sheets
- Emerging organizations with innovative ideas or practices with plenty of potential that have yet to produce results
- Industry leaders that may outperform their industry, sector, or the market
Often times, aggressively scaling small-to-midcap stocks are favored as growth stocks, as they have the furthest to climb charts.
Though it’s not unheard of to see high-priced companies continue to grow – just look at Amazon – it’s more likely for lower-priced stocks.
At least, if you bet on the right one.
Unfortunately, knowing which is the right one is the key – and the trick. Growth stocks are considered to have considerable room for expansion…until, suddenly, they don’t.
And when the bottom falls out beneath their propped-up prices, they’ll take your gains with them.
Value Stocks vs. Growth Stocks: What are the Differences?
Typically, growth investors enter and exit their positions faster: they want in when the stock soars and out when it begins to amble (or crash).
While most growth investors aren’t day traders, they often hop in and out of positions in a few years.
On the other hand, value often hold their positions for the long-term – potentially decades. The reason is simple: while growth stockspeak faster, value stocks often grow slowly but surely for years to come.
But beyond their investors, value and growth stocks carry a number of other differences, too, like their:
- Risk level. Typically, value stocks are considered less risky due to a decreased chance of continual downward pressure. But growth stocks are both riskier and more volatile than thanks to their growth spurts, lofty prices, and susceptibility to negative publicity.
- Prices. By definition, value stocks are priced lower than their fundamentals and the larger market, perhaps due to an outsize reaction to legal woes, negative publicity, or disappointing earnings. By contrast, growth stocks often overperform the same metrics.
- Dividend payments. Many value stocks pay regular dividends – and often have for years. But growth stocks often reinvest their entire profits into new operations, research and development, and expansions, leaving them no leftover profits to dole out.
Growth Stocks vs. Value Stocks: Which is Better?
The answer depends on your preferences and risk tolerance – but there’s no reason to make an either-or decision. In fact, adopting both approaches adapted to your comfort often generates better returns.
By combining rapid growth with long-term gains, you can take advantage of market cycles, short-term volatility, and the shifts that occur when a growth stock becomes a value stock (or vice versa).
Examples of Growth Stocks and Value Stocks
The definition of a growth vs. value stock can be subjective. For instance, when a stock’s price climbs into the hundreds of dollars per share, investors may consider it a value stock.
Other examples of growth and value stocks include:
(Notice how most of these growth stocks are tech-based? In the modern market, that’s no accident.)
- Bank of America Corporation
- General Mills
(Notice how Apple made both lists? That, too, is no accident.)
Are Growth Stocks Riskier than Value Stocks?
Growth stocks are usually considered riskier than value stocks.
While the reality may not always pan out as such, growth investors hope to find high-priced, fast-growing companies – many of which carry an outsize chance of crashing and burning.
At the same time, value investors look for those stocks that have already crashed (or ridden a slow wave down, as the case may be) so they can hop aboard before they rise again.
>> More: Active vs. Passive Investing
Historical Performances of Growth and Value Stocks
If you look at the historical performance of growth and value stocks, you’ll often find mixed performance results depending on the sector, time horizon, and period in history.
Usually, growth stocks perform well when interest rates fall, company earnings rise, and the economy expands. But when economies cool, growth stocks’ lofty prices make prime fodder for cutbacks.
By the same token, value stocks do well during economic downturns and subsequent recoveries but may drag during bull markets.
That said, some essential value stocks, like grocers and other retailers, may prop up during recessions.
But on the whole, growth stocks perform better in short-term spurts, while value stocks outperform across longer horizons.
And in five-year increments, both large-cap growth and value stocks even out to net the same returns.
Who is Value Investing Best for?
Typically, value investing is better for risk-averse investors with longer time horizons. While you can’t just “set and forget” any portfolio, those who prefer to rebalance only once or twice per year may feel more comfortable owning value names.
Who is Growth Investing Best for?
Growth investing is often employed by those who can eat bigger losses to chase bigger returns.
But since nothing is guaranteed, this strategy is better for active investors who can afford to lose more.
Should New Investors Invest in Value or Growth Stocks?
Typically speaking, new investors should dabble in both growth and value strategies.
By diversifying your portfolio within your risk tolerance, taking advantage of both short-term growth and long-term value trends can generate the best returns in the long run.
In theory, a well-balanced, diversified portfolio smooths out the inevitable bumps in the road.
Bottom Line: Growth vs. Value Investing – Which is Better?
Growth and value stocks both carry their merits, and investors who prefer either approach over the other may find success in their strategies.
However, most long-term investors find their returns boosted overall when they select both growth and value investments that fit their preferences, risk tolerance, and time horizon.