By Paul McCoy, CIMA®, AIF®
At different periods of time, the stock market appears to favor one of two stock types - value stocks or growth stocks. Since the 2008 market downturn, for example, the market has primarily favored growth stocks. But some big names are speculating that value stocks could be making a comeback due in part to big changes caused by the pandemic. These speculations, of course, do not guarantee performance.
As you watch what’s happening in the markets, it’s important to know what the difference is between value stocks and growth stocks.
What Is Value Investing?
The idea behind value investing is that investors are, essentially, bargain hunting. They’re looking for stocks that they believe are being 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 an opportunity to sell. Once they purchase a stock, value investors seek to ride the price upward as the security returns to its “fair market” price – selling it when this price objective is reached.
To determine a value investment, investors may examine the company’s balance sheet, financial statements, and cash flow statements to get a clear picture 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 an investor expects it to. A stock an investor believes to be undervalued may remain undervalued, or even drop in value.
What Is Growth Investing?
Growth investing essentially uses today’s information to identify tomorrow’s strongest stocks. The idea is to look for “winners” - stocks of companies within industries that are expected to experience substantial growth.
Growth investors seek companies in a position 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, in the hope that its price will continue to rise as the company grows and attracts more investors.
Where value investors may use analysis, growth investors use criteria. Growth investors are more concerned about whether a company is exhibiting behavior that suggests it will be one of tomorrow’s leaders; they are less focused on the value of the underlying company.
For example, growth investors may favor companies with a sustainable competitive advantage 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 an above-average price-to-earnings ratio (PE ratio), but they may in some cases be prone to higher volatility than value investments. 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.
Value investing and growth investing follow the same general purpose - to 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 different reasons.
In regards to your own portfolio, you may find that a mix of value and growth investments could provide a healthy and diverse assortment. Work with your investment advisor before making any decisions regarding your portfolio.