Equity investors often categorize stocks as either growth or value stocks. The growth vs value investing debate is decades old. Some investors prefer one style over the other. Both strategies aim to generate the best possible returns, but there are a number of differences between the two. In this value vs growth investing comparison, let’s check out how they differ and which style is better for you.
Warren Buffett has been the biggest proponent of value investing. Value investors look for stocks that appear to be undervalued because they have temporarily fallen out of favor for some reason. The idea is to find stocks whose market value doesn’t reflect their fundamental worth. In time, the market will realize its true worth and the stock will appreciate.
Value investors don’t chase the high-flying blue-chip stocks because the price could be too high relative to its fundamentals and earnings growth potential.
Value stocks have strong fundamentals. The stock may have fallen sharply due to investors’ overreaction to negative events such as lower than expected earnings, legal troubles, regulatory hurdles, negative publicity, or macroeconomic conditions. Value investors’ thesis is that solid companies are capable of surviving the temporary setbacks and deliver good returns in the long run.
Some stocks look cheap but they don’t have strong fundamentals or trustworthy management. Their competitive advantage might be eroding or they are struggling to compete with newer, more innovative companies. They are called value traps, which should be avoided at all costs.
Most value stocks pay healthy dividends. So, investors stand to benefit not only from stock price appreciation but also from dividends. Historically, value stocks have done well during an economic recovery. But they tend to lag behind growth stocks in sustained bull markets.
Growth investors seek capital appreciation over the long-term when they pick a stock. They are interested in businesses that are growing faster than their peers and the broader market. Instead of distributing their earnings to shareholders in the form of dividends, growth-obsessed businesses reinvest it to drive future growth.
Growth-focused companies spend heavily on R&D, expansion, and new initiatives. It’s “Go big or go home” for them. Some of their initiatives may fail despite all their efforts. Growth companies offer significant upside potential, but they could be riskier bets.
Growth stocks often command a premium, trading at higher price-to-earnings and price-to-book ratios. Investors believe they will be able to sell the stock at an even higher price in the future as the company continues to grow. Some growth companies manage to achieve high earnings growth even in times of economic slowdown. But there is no guarantee that they will sustain the robust earnings growth.
Growth stocks tend to be highly volatile. They sometimes trade at lofty valuations, and the price could fall dramatically on any negative news.
Value vs growth investing: Which one suits you?
Both investing styles have their own set of benefits. The value vs growth investing debate has been going on for decades. Historically, value stocks have delivered excellent returns early in an economic recovery. But growth stocks have done well in sustained bull markets. Growth stocks also tend to perform better when interest rates are declining and corporate earnings are rising.
Growth investing is for people with appetite for high risk and high volatility. It’s for people with little interest in dividend income. Growth investing is suitable for those who have a knack for picking winners early and sitting tight through volatility until the company realizes its full potential.
Value stocks are far less expensive than growth stocks. And they are less risky because they have a proven and profitable business model. The stock may appreciate when other investors realize its real worth.
Even if the stock doesn’t appreciate as much as you expected, such companies distribute a large portion of their earnings among shareholders in the form of dividends or stock buybacks. Value stocks are for people who prefer lower volatility in stock prices.
Value vs growth investing: Do you really have to choose between the two?
Not necessarily. In fact, some stocks have both value and growth elements. One style does better than the other in certain economic environments, and vice-versa. As an investor, you can take advantage of both styles to generate high returns in the long-run. A portfolio consisting of both value and growth stocks will get the best of both worlds.
Billionaire investor Warren Buffett wrote in his 1992 letter to shareholders that most analysts and finance experts view the two investing styles – value and growth – as the opposites. Buffett believes the two styles are “joined at the hip.” Growth is always an important component when calculating value.