Value investing and growth investing are two different investing styles. Value stocks usually present an opportunity to buy shares below their actual value, while growth stocks exhibit above-average revenue and earnings growth potential.
Wall Street likes to neatly categorize stocks as either growth stocks or value stocks. The truth is a bit more complicated since some stocks have elements of both value and growth. Nevertheless, there are important differences between growth and value stocks, and many investors prefer one investing style over the other.
Growth stocks
Growth stocks
Growth companies prioritize quickly transitioning from small, up-and-coming businesses to leaders in their respective industries. Early on, these companies tend to concentrate on building up their revenue, often at the cost of delaying profitability. After a period of time, growth companies start focusing more on maximizing profits.
As those key financial metrics grow, the perceived value of the company rises in the eyes of growth-minded investors. That can create a positive feedback loop. A rising stock price can boost a company's reputation, helping it win even more business opportunities.
Growth stocks tend to have relatively high valuations as measured by price-to-earnings or price-to-book value ratios. However, they also see faster growth in revenue and income than their peers.
Value stocks
Value stocks
Value stocks are publicly traded companies that trade for cheap valuations relative to their earnings and long-term growth potential. They don't have flashy growth characteristics.
Companies considered value stocks tend to have steady, predictable business models that generate modest gains in revenue and earnings over time. Sometimes, you can find value stocks with companies that are in decline. Still, their stock price is so low that it understates the value of their future profit potential.
Which is better?
Which is better: growth or value?
Both growth stocks and value stocks offer lucrative investing opportunities to their shareholders. The best investment style for you depends largely on your personal financial goals and your investing preferences.
Growth stocks are more likely to be appealing if the following apply to you:
- You're not interested in current income from your portfolio. Most growth companies avoid paying significant dividend income to their shareholders. That's because they prefer to use all available cash to reinvest directly into their business to generate faster growth.
- You're comfortable with big stock price moves. The price of a growth stock tends to be extremely sensitive to changes in future prospects for a company's business. When things go better than expected, growth stocks can soar in price. When they disappoint, higher-priced growth stocks can fall back to Earth just as quickly.
- You're confident you can pick out winners in emerging industries. You'll often find growth stocks in fast-moving areas of the economy, such as the technology sector. It's common for many different growth companies to compete against each other. You'll need to pick as many eventual winners in an industry as possible while avoiding losers.
- You have plenty of time before you'll need your money back. Growth stocks can take a long time to realize their full potential and often suffer setbacks along the way. It's critical that you have a long enough time horizon to give the company a chance to grow.
Value stocks may look more attractive if you seek out these characteristics:
- You want current income from your portfolio. Many value stocks pay their shareholders substantial amounts of cash as dividends. Because such businesses lack significant growth opportunities, they have to make their stock attractive in other ways. Paying out attractive dividend yields is one way to get investors to look at a stock.
- You prefer more stable stock prices. Value stocks don't tend to see large movements in either direction. As long as their business conditions remain within predictable ranges, stock price volatility is usually low.
- You're confident you can avoid value traps. In many cases, stocks that look cheap are value traps -- cheap for a good reason. It could be that a company has lost its competitive edge or can't keep up with the pace of innovation. You'll have to be able to look past attractive valuations to see when a company's future business prospects are poor.
- You want a more immediate payoff from your investment. Value stocks don't turn things around overnight. However, if a company is successful in getting its business moving in the right direction, its stock price can rise quickly. The best value investors identify and buy shares of those stocks before other investors catch on.
Finally, when it comes to overall long-term performance, there's no clear-cut winner between growth and value stocks. When economic conditions are good, growth stocks modestly outperform value stocks on average. During more difficult economic times, value stocks tend to hold up better. Therefore, which group outperforms depends greatly on the specific period you're considering.
Indexes
Tracking growth and value indexes
These trends can be seen in growth and value indexes, which are benchmarks designed to track each group of stocks.
The S&P 500 Growth Index (SPYG -2.88%) draws from the roughly 500 stocks in the S&P 500. It selects the stocks with the best three-year revenue and earnings per share growth and the strongest upward price momentum. The S&P 500 Value Index (SPYV -1.5%) selects stocks with the best valuations based on several major stock valuation metrics.
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Which is right for you?
There's no reason you can't own growth stocks and value stocks. Each group has its own attractive qualities. Having diversified exposure to both in your portfolio can give you the best of both worlds.
It's also fine if you identify more with one investing style than the other. Once you settle on your investment goals, you'll have a better sense of whether you're a growth investor, a value investor, or a bit of both.
Value vs. growth investing FAQ
Which is better, growth stocks or value stocks?
Growth stocks and value stocks are each appealing in their own right. They perform roughly in line with each other over a full economic cycle. Growth stocks will outperform when the economy is strong, while value stocks tend to hold up better during a downturn.
Is the S&P 500 considered growth or value?
The S&P 500 consists of 500 of the largest and most profitable publicly traded companies in the U.S. It comprises value stocks and growth stocks. Because the index is weighted by market capitalization, it can tilt toward growth stocks in some instances and value stocks in others. Regardless, it always contains a blend of both.
How can you determine whether a stock is growth or value?
Growth stocks are shares issued by companies focused on growing revenue and maximizing their potential earnings through market share and addressable market expansion. Their profits may suffer in the short run, but the expected payoff in the long run is worth it.
Value stocks are shares that trade below their intrinsic value based on the fundamental earnings power of a business. Ideally, you want to buy stocks with good growth potential trading at a fair valuation or better.
