Before we can answer that, lets first define what a “value stock” is and what is considered a “growth stock.”
Keep in mind, the following definitions are not hard and fast rules, but rather broad ideas/principals, and investors will have slightly different definitions or thresholds as to which bucket a stock should be placed.
Value Stock
Some key characteristics of value stocks are-
- Undervalued Compared to Their Peers. Value stocks trade at lower valuations than other companies in their sector or industry. When share prices fall but a company’s underlying fundamentals remain strong, value stocks become “affordable” in the short-term, and hopefully lead to long-term gains.
- Lower P/E Ratios or Other Valuation Metrics than the Broad Market. Even beyond a company’s closest competitors, value stocks are generally lower-priced than the broader market in terms of price-to-earnings (P/E) ratio, especially compared to growth stocks. Other valuation metrics can include: (P/S) price-to-sales, (DCF) discounted cash flow, (P/B) price-to-book, etc.
- Typically Less Growth but Reliable Income Streams. Usually larger and more established businesses, earnings of value stocks grow at modest but consistent clips. Because of their size, many companies opt to pay significant amounts of earnings directly to shareholders in the form of dividends, rather than reinvest them back into the business.
- Less Volatile than the Broad Market. Because value stocks are priced more conservatively, share prices often move less than the market average, and expectations are lower when companies report earnings. But the trade-off to price stability may be a longer holding period until pay out, so value stocks can be well-suited for long-term investors.
Growth Stock
The key characteristics of growth stocks are-
- Track Record of Earnings and Revenue Growth. Growth stocks are typically less mature but have grown their revenue and earnings at a better-than-average rate and are expected to continue doing so. Often, growth companies will ignore profitability to focus on top line growth. Consistently high growth rates for key top and bottom-line metrics can justify their relatively higher valuations…but not always.
- Higher P/E Ratios than the Broad Market. Because investors expect their earnings to continue growing, growth stocks carry high valuations such as above average P/E, price-to-book (P/B), and price-to-sales (P/S) ratios. A strong Forward P/E, which considers estimates made by the company and Wall Street analysts, indicates an expectation of continued growth for these companies.
- Anticipated Higher Growth, Albeit with Less Reliable Return On Investment. Growth companies typically opt to reinvest earnings instead of paying dividends to shareholders. This makes an investor’s ROI dependent on the share price increasing, but when a growth stock plows earnings back into the business, it increases the likelihood of capital appreciation.
- More Volatile than the Broad Market. Due to their higher valuations, prices of growth stocks tend to be more volatile than the broader market average. When share prices are already lofty, they can plummet quickly if a company misses expectations, or when negative news comes out.
In addition to looking at and understanding the value vs. growth question, investors also need to consider whether to purchase individual stocks, mutual funds, or ETF’s to implement these strategies.
Some general rules of thumb-
Growth may be right for you if you’re comfortable with larger price movements and you aren’t in need of current income (by way of dividends). However, you might prefer value if you’re looking for more stable investments that regularly pay dividends. There’s also a case to be made for including both value and growth in your portfolio to smooth out times of volatility and capture the best of both worlds.
Value vs Growth, which is better for you?
Your preference for, or belief in, value vs. growth typically comes down to your investment objectives, risk tolerance, and time horizon. You may prefer to achieve exposure to growth or value, or some combination of both. Again, these are broad strokes, the devil is in the details, so doing a thorough analysis (as always) should be done prior to any investment decision.
-Paul R. Rossi, CFA