Depending on when you look at it, the stock market appears to favor one of two stock types - value stocks or growth stocks. As an example, since the 2008 market downturn, the market has seemed to favor growth stocks. If you’re paying attention however, there are some big names speculating that value stocks could be making a comeback. This is due in part to changes caused by the COVID-19 pandemic. These speculations, of course, do not guarantee performance.
As you watch what’s going on in the markets, it is important to understand the difference between value stocks and growth stocks.
What Is Value Investing?
The main idea behind value investing is that investors are, essentially, hunting for bargains. They’re keeping an eye out for stocks that they believe are currently undervalued by the market as a whole. If they find a stock that they consider to be underpriced, they recognize that as an opportunity to buy. If they consider the stock to be overpriced, it’s an opportunity to sell. Once the stock is in their portfolio, value investors seek to ride the price upward as the security returns to its “fair market” price – selling it when the 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.
What Are The Risks of Value Investing?
There’s no guarantee that a stock will appreciate to the value an investor expects it to. A stock that an investor believes to be undervalued may remain undervalued, or it could even drop in value.
What Is Growth Investing?
Essentially, growth investing uses today’s information to identify what could be tomorrow’s strongest stocks. The basic idea is to look for “winners” - stocks of companies within industries that are expected to experience more substantial growth than others.
Growth investors seek to find companies in a position to generate revenues or earnings greater than what the market is expecting. When growth investors come across a promising stock, they buy it, even though it may have already experienced rapid price appreciation. They make the purchase with the hope that the stock price will continue to rise as the company grows and attracts more investors.
Where value investors may use analysis, growth investors will use criteria. Growth investors tend to be more concerned with finding clues that point to the company being one of tomorrow’s leaders than they are on the value of the underlying company.
For instance, growth investors may favor companies that have a sustainable competitive advantage that are predicted to experience revenue growth rapidly, that are effective at containing cost and that have placed an experienced management team in charge.
What Are The Risks of Growth Investing?
Despite often having an above-average price-to-earnings ratio (PE ratio), in some cases, growth investments may be prone to higher volatility than value investments. These investments are typically bought at an already high price, and there’s always the risk that price will fall or cease to rise any further than it already has.
Both value investing and growth investing follow the same general idea - to buy low and sell high. While they frequently overlap in criteria, the main difference between these two guiding principles is this: value investments have generally already proven their worth, while growth investments show potential for future worth. When you think about it, both investment types are counting on the assumption that the value of the stock will rise, but for different reasons.
Regarding your own personal portfolio, you may have come to the conclusion that a mix of value and growth investments could provide a healthy and diverse assortment. You should talk with your trusted financial professional before making any decisions or changing your portfolio.