Investing is as much an art as it is a science. One of the most important decisions you’ll make as an investor is choosing between value vs. growth stocks. On the one hand, value stocks offer an affordable way to get your foot in the door. However, on the other hand, growth stocks offer the potential for rapid growth and large returns.
Which strategy is right for you? Consider this article your crash course in growth vs. value investing, which will help you refine your strategy so you can make the most from your portfolio.
The Difference Between Growth and Value Stocks
First, what is the difference between value and growth stocks? Technically, there’s no absolute definition that governs either category, though there are still some general characteristics that distinguish value vs. growth stocks.
What Are Growth Stocks?
Growth stocks represent companies with better-than-average gains compared to other companies in the market or their industry. Startup companies can often be growth stocks since their value usually grows as the company gains its footing.
But any company that takes on a new initiative or broadens its overall value can experience a period of growth, and analysts who can tap into that potential have the ability to increase the value of their investment.
How can you tell what stocks have the greatest potential for growth? Look for things like:
- Is the stock at a higher price than the overall market?
- Is the stock growing at a faster rate than other companies in the industry?
- Does the company offer something of unique value to justify future growth?
Basically, growth stocks depend on your ability to assess the company’s future value and make a commitment in the hopes of future growth. Admittedly, there’s no guarantee, but when companies take off, you can anticipate massive rewards.
What Are Value Stocks?
Value stocks are those that are believed to be trading below their actual worth. These tend to be larger, well-established companies since these stocks tend to be easier to evaluate to ensure that the drop in price doesn’t reflect a dip in the company’s actual value.
How do you know which stocks are considered “value stocks?” Look at trends like:
- Is the stock poorly valued compared to the overall market?
- Is the stock valued lower than those of other companies in the industry?
- Is the company impacted by a specific, temporary event, like the pandemic?
There can be many reasons that a company’s stocks can be undervalued, ranging from public perception to recent changes in management. But as long as the company has a strong financial history, it can be expected to rebound, allowing investors to reap the profits.
Advantages of Growth Investing vs. Value Investing
There are many advantages to pursuing growth vs. value stocks. These advantages include:
High Earnings Potential
The greatest benefit of a growth stock is the high earnings potential. Basically, a growth stock lets investors get in on the ground floor, financially speaking, and then benefit when the company experiences massive profits. A single big investment can make you very, very rich.
For example, when Amazon debuted in 1997, its IPO was just $18 per share. Had you purchased $1,000 in stock in 1997, it would be worth over $1.3 million today. These stories aren’t common but showcase the meteoric profits that can be achieved from growth stocks.
Greater Diversification
Frequently, growth stocks will be in sectors outside the ones that usually comprise your investment portfolio. In fact, some fund managers may insist that you include additional stocks when you invest in a growth company, as this can bring greater stability to your portfolio as a whole.
Either way, you’ll increase the diversity of your investments, which can help you attain stability long-term.
Timing is Less Important
With other types of stocks, you’ll need to time your investments in order to maximize your profits. This approach typically means you have a relatively narrow window before a stock price jumps up and you lose the ability to truly benefit from the investment.
But with growth stocks, the company tends to grow over time, which means that as long as you jump on board at some point during this growth period, you’ll be able to experience the benefits of the company’s success.
Advantages of Value Investing vs. Growth Investing
While these types of growth stocks sound appealing, there are a lot of advantages of value stocks vs. growth stocks. These advantages include:
Lower Initial Cost
The greatest advantage of value stocks is that they offer a relatively low price.
For instance, if there’s a larger company that you’ve been eyeing for a while, you can take advantage of a market low point and snatch a few shares for less than they’re typically worth. This approach makes it easier to invest since you’ll be saving money on the cost of the initial investment.
Greater Stability
Value stocks tend to be larger companies — those that are going through a low period for one reason or another.
Once the stock rebounds, these companies tend to offer greater long-term stability. This stability distinguishes value stocks versus growth stocks since the same volatility that gives growth stocks their earnings potential also confers significant financial risk.
Possibility of Dividends
Again, value stocks typically represent larger companies. Large companies also tend to offer additional benefits, such as dividends.
Dividend payments may be small, but they provide investors with some passive income in addition to the value of the stock shares themselves. Growth stocks can also offer dividends, but smaller companies are less likely to offer these features than larger corporations.
When to Consider Growth vs. Value Stocks
We’re not trying to suggest that growth or value stocks are necessarily superior to one another. In fact, there may be times when investors might consider one versus the other. How do you know when to use each investment strategy?
When to Consider Growth Stocks
There are no absolute rules, but growth stocks have greater potential to grow when interest rates are falling, and company earnings are rising. However, growth stocks make less sense when the economy as a whole is cooling.
When to Consider Value Stocks
Value stocks are good to grab during an obvious period of economic recession, such as the 2020 pandemic. Value stocks, therefore, perform well during periods of economic recovery, but you won’t find a lot of value stocks during a sustained bull market.
Why Not Both? Choosing Growth and Value Stocks
So far, this guide has emphasized the relative value of growth vs. value stocks and vice versa. But it’s not necessarily an either-or scenario. Savvy investors can benefit from employing both investment strategies in their portfolio, so long as this aligns with their overall investment goals.
For long-term investors, value and growth stocks offer the possibility of gains over time. Value stocks also offer the stability to mitigate the higher risk of growth stocks. But for those looking for explosive gains, there can be no substitute for investing in a stock that offers serious growth potential.
The point is that neither strategy is absolute, and investors might consider how both of these stocks can be incorporated into a well-balanced stock portfolio and provide a meaningful return on the investment over time.
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