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Value stocks and growth stocks: Definition, examples, comparison and investor considerations
Imagine your ideal portfolio that’s tailored to your unique financial goals, blending the stability of value stocks with the vibrant potential of growth stocks.
This article will guide you through comparisons and insights for both growth and value stocks, helping you make informed decisions that propel your portfolio forward.
This article will guide you through comparisons and insights for both growth and value stocks, helping you make informed decisions that propel your portfolio forward.
QUOTE
"In the short run, the market is a voting machine, but in the long run, it is a weighing machine."
Big ideas
- Value stocks, often undervalued by the market, can provide better long-term returns compared to growth stocks, which are more volatile and can be overvalued. This potential for higher returns makes value stocks an attractive option for long-term investors seeking to capitalise on market inefficiencies.
- Blending value and growth strategies in a portfolio can offer a balanced approach to risk management. This mix allows investors to enjoy the stability of value stocks and the growth potential of growth stocks, leading to a diversified portfolio that can withstand market fluctuations more effectively.
- Technological and economic changes continually reshape the definitions of 'value' and 'growth' sectors. As industries evolve, sectors once considered purely growth or value can shift, presenting new opportunities for investors. Staying agile and adapting investment strategies to these changes can help capture emerging value and growth prospects.
Value vs growth stocks: Market trends
The dynamic interplay between value and growth stocks often reflects trends in the broader market as well as investor sentiment.
The clear trend of the past few years has been the outperformance of growth stocks vs value stocks. This, for the most part, has come alongside a buoyant time for stock markets, accompanied by historically low interest rates.
The clear trend of the past few years has been the outperformance of growth stocks vs value stocks. This, for the most part, has come alongside a buoyant time for stock markets, accompanied by historically low interest rates.
During financial uncertainty or market downswings, some investors are inclined towards value stocks due to their alleged stability and less volatile nature. Conversely, in a period of a thriving economy, growth stocks tend to take centre stage, driven by the optimism of investors and eager anticipation of future earnings growth.
Understanding value stocks: Definition and meaning
Value stocks represent shares in companies that are perceived to trade below what they are fundamentally worth.
These undervalued securities often catch the eye of investors looking for ‘hidden gems’ in the market, those businesses whose current share prices don't fully reflect their intrinsic value due to various reasons, such as market overreactions to short-term challenges.
These undervalued securities often catch the eye of investors looking for ‘hidden gems’ in the market, those businesses whose current share prices don't fully reflect their intrinsic value due to various reasons, such as market overreactions to short-term challenges.
Characteristics of value stocks
In general, these shares are characterised by a low three important criteria:
- Low P/E ratio
- High dividend yields
- Strong balance sheets
These firms are usually established businesses that have, through time, built a business model in an industry that is currently out of the limelight.
The conservative valuation metrics of these stocks suggest that investors are not factoring in the potential for future growth, possibly due to current market sentiment or short-term obstacles the companies will face.
The conservative valuation metrics of these stocks suggest that investors are not factoring in the potential for future growth, possibly due to current market sentiment or short-term obstacles the companies will face.
Examples of value stocks
Sectors like finance, utilities and consumer staples tend to host a high concentration of value stocks because they are industries providing standard essential services without exhibiting much of a growth rate. However, value stocks can be found across all industries and sectors.
There are different ways to start researching which value stocks to include in your portfolio such as using a stock screener. A screener can help you scan for value characteristics in stocks, such as by P/E and dividend yield.
Another simpler way is to look for lists of recommended value stocks on credible websites such as Forbes. While these lists shouldn’t be followed blindly, they can provide a source of ideas or inspiration. In an article titled: ‘10 Best Value Stocks Of February 2024’ Forbes recommended the following:
There are different ways to start researching which value stocks to include in your portfolio such as using a stock screener. A screener can help you scan for value characteristics in stocks, such as by P/E and dividend yield.
Another simpler way is to look for lists of recommended value stocks on credible websites such as Forbes. While these lists shouldn’t be followed blindly, they can provide a source of ideas or inspiration. In an article titled: ‘10 Best Value Stocks Of February 2024’ Forbes recommended the following:
Company | PEG ratio | P/E ratio |
0.3 | 15.7 | |
0.3 | 10.1 | |
0.3 | 8.6 | |
0.4 | 12.6 | |
0.4 | 10.9 | |
0.4 | 8.0 | |
0.6 | 7.6 | |
1.1 | 10.9 | |
1.2 | 16.1 |
The stocks listed have been filtered for a PEG ratio of less than 1.2. This criterion aims to identify stocks that offer a balance between their current valuation and future earnings potential, making them potentially more attractive investments.
DEFINITION & FORMULA
The Price to Earnings Growth (PEG) ratio is a valuation metric that combines a stock's price-to-earnings (P/E) ratio with its expected earnings growth rate, offering a fuller picture of a stock's valuation by accounting for growth.
PEG Ratio = Price to Earnings (P/E) Ratio / Expected Earnings Growth Rate
PEG Ratio = Price to Earnings (P/E) Ratio / Expected Earnings Growth Rate
Benefits and risks of value stocks
Value stocks have several advantages that are appealing to investors, especially for regular income and in tougher market circumstances:
- Bear market resilience: These stocks usually perform better than their growth counterparts during bear markets due to being undervalued most of the time. This is because their prices generally reflect lower expectations from the market. As a consequence, plummeting market conditions cause minimal damage to them, and this offers some sort of shield against extreme losses.
- Reduced volatility: Unlike growth stocks, value stocks exhibit lower volatility levels. In most situations, these firms have well-established models for doing business that are hardly affected by sentiment or speculative trading, which makes owning them attractive to people who dislike risk.
- Regular dividends: Top-value stocks provide regular dividend payments, thereby making them reliable sources of income for investors over the long term. These dividends can be profitable even if there has not been much increase in stock price since the investment was made. For buy-and-hold investors who focus on value stocks compounding this factor contributes greatly to overall returns.
But the market has a habit of taking longer than expected to recognise the true worth of these firms, hence leading them to underperform for long periods. Worse still is the possibility that these shares were sold off because there were some fundamental issues within the companies capable of taking the share price down even further.
Value stocks investing strategies
There are various strategies employed by investors focusing on value stocks to identify and capitalise on these opportunities. To determine whether or not a security is underpriced by comparing it against metrics such as P/E ratios, debt levels, and profitability, one needs to undertake fundamental analysis, which involves studying past financial statements.
To further your understanding in this area, you can read the full Trading 212 guide on How to read financial statements.
Another strategy to integrate into your value investing is diversification. Owning value stocks across sectors, industries and internationally spreads out your exposure, thus reducing the negative impact of any one company or industry in case of a slump.
To further your understanding in this area, you can read the full Trading 212 guide on How to read financial statements.
Another strategy to integrate into your value investing is diversification. Owning value stocks across sectors, industries and internationally spreads out your exposure, thus reducing the negative impact of any one company or industry in case of a slump.
Understanding growth stocks: Definition and meaning
DEFINITION
Growth stocks are shares in companies that exhibit potential for above-average growth in revenue and earnings, often at a faster pace than the overall market.
These companies usually reinvest their earnings into expansion initiatives, research and development, and other activities to fuel further growth rather than paying dividends to shareholders.
These companies usually reinvest their earnings into expansion initiatives, research and development, and other activities to fuel further growth rather than paying dividends to shareholders.
Characteristics of growth stocks
In general, growth stocks are characterised by three important criteria that distinguish them from value stocks:
- High Price-to-Earnings (P/E) Ratio
- Low or No Dividend Yields
- Aggressive Growth Prospects
Growth stocks typically have high P/E ratios, reflecting investors' willingness to pay a premium for expected future earnings growth. A high P/E ratio suggests that the market has high expectations for a company's future growth and profitability.
Unlike value stocks, growth stocks often offer low or no dividend yields. This is because growth companies usually reinvest their earnings back into the business to fuel further growth, rather than distributing them as dividends to shareholders. Investors in growth stocks are primarily looking for capital appreciation.
Growth stocks are often characterised by strong revenue growth and investors are speculating that this will eventually be complemented by strong earnings growth. These companies are usually in the early or middle stages of their development and operate in sectors with high growth potential. Their balance sheets might show less immediate stability compared to value stocks.
Unlike value stocks, growth stocks often offer low or no dividend yields. This is because growth companies usually reinvest their earnings back into the business to fuel further growth, rather than distributing them as dividends to shareholders. Investors in growth stocks are primarily looking for capital appreciation.
Growth stocks are often characterised by strong revenue growth and investors are speculating that this will eventually be complemented by strong earnings growth. These companies are usually in the early or middle stages of their development and operate in sectors with high growth potential. Their balance sheets might show less immediate stability compared to value stocks.
Examples of growth stocks
Technology firms have some of the best examples available of the potential risks and rewards on offer for growth investors, especially those that deal with cloud computing, artificial intelligence, and renewable energy. These companies, therefore, stand to see their stock prices rise because their businesses are innovative with new models of doing business resulting in higher revenues and market share, or fail because the new initiative didn’t stand the test of time.
Company | 3-year sales growth | Industry |
39% | Automotive | |
39% | Semiconductors | |
24% | E-commerce | |
17% | Cloud software | |
16% | Digital payments | |
15% | Digital payments | |
10% | E-commerce | |
10% | E-commerce & Cloud computing | |
10% | Digital advertising | |
7% | Streaming entertainment |
Past performance is no guarantee of future results.This information does not represent investment advice, recommendation or strategy recommendation, or inducement to buy or sell financial instruments.
Benefits and risks of growth stocks
Growth stocks offer many benefits to shareholders seeking high returns on investment:
- Earnings potential: Potential for considerable appreciation in share price is among the key factors attracting investors into these companies.
For instance, from its initial public offering (IPO) price of $1.50 (adjusted for any stock splits), AMZN's share price has increased by approximately 113 times to its current price of approx. $170. Hence, the possibility of rapid growth in worth is a big drawcard for those looking at beating the average profit on investments. - Early bird opportunity: Growth stock investing also provides an occasion where an investor can put his or her money behind the firms that might become future leaders but which do not currently hold such positions. Selecting growth stocks can generate the thrill and potential profit through finding a disruptor in its early stage of development, unlike buying shares of already established companies.
- Capital appreciation over dividends: Instead of paying out dividends, growth stocks tend to channel more money back into the business for further expansion, using the would-be profits for the chance at higher future payouts. This kind of approach may sound attractive to people with long-term plans since it does not matter if such firms distribute immediate income via dividends or not.
Growth stocks nevertheless carry outsized risks compared to value stocks. Their higher valuations mean that they tend to be more volatile and, hence can see bigger drawdowns during market pullbacks.
Furthermore, when a firm does not meet its expansion estimates, then there is a likelihood that its share price will go down, and quite often by a lot. Even the best growth stocks inevitably see these periodic losses of confidence in their growth, creating a rocky ride for growth investors along the way.
Naturally, speculating based on future growth potential rather than current valuations adds an additional element of riskiness.
Furthermore, when a firm does not meet its expansion estimates, then there is a likelihood that its share price will go down, and quite often by a lot. Even the best growth stocks inevitably see these periodic losses of confidence in their growth, creating a rocky ride for growth investors along the way.
Naturally, speculating based on future growth potential rather than current valuations adds an additional element of riskiness.
Growth stocks investing strategies
Finding tomorrow’s Apple or Amazon tends to mean picking through slightly less tangible data than one would do when value investing.
The prerequisite is strong revenue growth, which can then be followed by a thorough look at attributes such as sustainable competitive advantages, management team and visible growth strategy. Analysis using market trends can help traders identify those whose values will rise within this category.
Just like value investing, diversification is important even in the case of growth investments so as to curb risks associated with its inadequacies rather than putting all eggs into one basket. It may include spreading your growth stock portfolio across different industry groups or sectors within the category.
The prerequisite is strong revenue growth, which can then be followed by a thorough look at attributes such as sustainable competitive advantages, management team and visible growth strategy. Analysis using market trends can help traders identify those whose values will rise within this category.
Just like value investing, diversification is important even in the case of growth investments so as to curb risks associated with its inadequacies rather than putting all eggs into one basket. It may include spreading your growth stock portfolio across different industry groups or sectors within the category.
NOTE
When buying growth stocks, investment timing may be critical as they tend to have higher volatility. Thus, the accuracy of decisions on entry and exit points is vital since these can make a great difference in terms of returns.
GARP investing: Growth at a reasonable price
Growth at a Reasonable Price (GARP) investing combines value and growth investing. GARP investors hunt for companies with good growth prospects but are not as expensive as typical growth stocks, looking for an equilibrium of undervalued assets and high potential to grow.
To gauge if a stock is overvalued or undervalued, the backbone of GARP investment is finding reasonable PEG ratios. A PEG ratio below 1 is often considered desirable, meaning that the market prices are not keeping pace with the company’s earnings growth estimates hence possibly offering a value.
To gauge if a stock is overvalued or undervalued, the backbone of GARP investment is finding reasonable PEG ratios. A PEG ratio below 1 is often considered desirable, meaning that the market prices are not keeping pace with the company’s earnings growth estimates hence possibly offering a value.
Value vs growth stocks: An overview
| Value investing | Growth investing |
Valuation | Undervalued (low P/E ratios) | Overvalued (high P/E ratios) |
Dividends | More common | Less common |
Volatility | Lower | Higher |
Companies with | Stronger cash flow Steady income Priced below intrinsic | Lower cash flows Low (if any) income Strong earnings growth potential |
Sectors | Energy Financial Healthcare Industrials | Tech Communications Consumer discretionary |
Value vs growth stocks: Investor considerations
When choosing between value and growth stocks, investors should consider their risk tolerance, investment horizon, and market conditions.
Value investing is suitable for people who seek conservative opportunities that can yield consistent returns, while those looking forward to capital appreciation may opt for growth investments despite high volatility.
Value investing is suitable for people who seek conservative opportunities that can yield consistent returns, while those looking forward to capital appreciation may opt for growth investments despite high volatility.
A well-diversified portfolio often includes a mix of value and growth stocks so as to strike a balance between risk-taking ability vis-à-vis expected rewards.
The knowledge of what causes economic swings, together with understanding cyclical variations in markets, enable adjustment of values and growths in one’s portfolio. Moreover, knowledge of the behaviour of growth and value stocks under varying volatility regimes can further refine investment strategies.
Incorporating both value and growth stocks in investment portfolios can provide a balanced approach to capital appreciation and income generation. Dividend payments as predictable earnings could attract investors towards value stocks, while significant capital gains opportunities are offered by growth stock investments.
Incorporating both value and growth stocks in investment portfolios can provide a balanced approach to capital appreciation and income generation. Dividend payments as predictable earnings could attract investors towards value stocks, while significant capital gains opportunities are offered by growth stock investments.
Recap
By weighing the benefits and risks associated with value and growth stocks, investors can tailor their portfolios for personal risk tolerances and financial objectives that capture both strategies in a balanced and resilient approach to investing.
FAQ
Q: What's the difference between value stocks and growth stocks?
Intrinsic value and financial performance are some factors used when determining whether a stock is either a value or a growth one. Generally speaking, this type of equity has a low P/E ratio indicating undervaluation and pays dividends. For instance, they pay dividends less often than their growth counterparts, whose primary purpose is reinvesting company earnings instead of distributing them towards shareholders’ returns.
Q: What is the difference between growth stocks and income stocks?
Growth stocks concentrate on capital appreciation, which means they reinvest profits for business expansion leading to a rise in stock prices. Income stocks, however, are known for their stable dividend payouts, meaning that they provide regular incomes for shareholders and are usually found in well-established companies with consistent cash flows.
Q: What are good examples of value stocks?
Value stocks are common in industries such as finance, utilities, and consumer staples. These sectors have solid financials, but the market underestimates their value. For instance, this could be a utility firm with good financial standing that pays out steady dividends at a low price-per-earnings ratio (P/E).
Q: Which is riskier - growth or value stocks?
Growth stocks tend to have higher volatility, and investors’ willingness to pay premium prices on potential future earnings would make them risky compared to value stocks. On the other hand, when it comes to market downturns, those focusing on undervalued firms with good fundamentals, like Value stocks, may be more resilient with fewer risks involved.
