Growth vs. value investing. Which is best?

Growth investing and value investing are the names given to different investing styles. What’s the difference between the two- and which is ‘better’?

 

Investors will often classify individual stocks as either growth or value to help determine if the stock should be used as part of a growth or value investing strategy. Things are not that black and white and some stocks exhibit qualities of both. Nonetheless, distinguishing between the two categories is still a useful exercise - either to define your investing style or to keep a balanced portfolio.

 

Famous examples

Before we dig into the characteristics of each style, let’s look at some classic examples of companies that fit into growth or value. These are not recommendations but merely famous companies that should give you a feeling about which kind of company fits into which style.

 

Growth

Value

Tesla (TSLA)

Coca-Cola (KO)

Amazon (AMZN)

Proctor & Gamble (PG)

Facebook (FB)

Walmart (WMT)

Netflix (NFLX)

Johnson & Johnson (JNJ)

Alphabet (GOOG)

Cisco Systems (CSCO)

 

Whether an investor will label a stock as a ‘growth stock’ or a ‘value stock’ is a function of past earnings and stock price performance.

 

Define: growth stocks

Growth investing involves picking stocks that are growing fast in the belief that they will keep growing, ideally even faster. The idea is investors buy the stocks before the company grows its earnings to full potential. How do you find growth stocks?

 

  1. Rising sales. You need to see that there is high demand for the company’s good and services. In the modern era, user growth has surpassed sales as a more useful measure of growth in technology companies - however in most industries, sales is the number one statistics look see. Young, fast growing companies will typically reinvest profits to fuel future growth, meaning the company is less or even unprofitable.
  2. High P/E. Growth investing does not mean waiting for low prices - it typically means buying high and trying to sell higher. As mentioned above, earnings will be low because they are being reinvested in growth, while investors see the rising sales and pay up for future growth, which together leave a high price: earnings (P/E) ratio
  3. High volatility. The term often floated around is ‘priced to perfection’. If these companies disappoint high expectations, the stocks can drop much more than the overall market. On the flipside, the development of new products as well as the opportunity for M&A make big upticks in the price more likely too.

 

Define: value stocks

Value stocks are companies where the price is low and earnings growth has perhaps been slower or even declining. Value investing is with the logic that a good company is being underappreciated by the market and that its fortunes will soon turn around. How do you find value stocks?

 

  1. Dividends. A value stock has typically seen its sales growth level off, and will aim more for consistency in its sales growth. This consistency translates to its earnings, which allows the firm to pay out a regular dividend, giving shareholders an income.
  2. Low P/E. These stocks are typically ‘undervalued’ - meaning investors are will to pay less for each $1 the company earns. Oftentimes these companies are very profitable, but the profit growth is flat or low. Should the profit growth begin to accelerate again, the share price will move to reflect that.
  3. Low volatility. Since investors tend to hold these stocks more for their dividend and are less sensitive to changes in the earnings of the company, the price tends to move less when the outlook for the company changes.

 

Which one is better?

In a word, neither. There are periods of time when either growth or value will outperform. Typically growth outperforms in a bull market and value outperforms in a bear market.

The following chart shows rolling three-year total return (including dividends) for the Russell 1000 Growth and Russell 1000 Value over the last 30 years.

 

value-vs-growth-stocks-performance-chart

 

What about now?

It’s true to say that the last decade (since the ’08 financial crisis) has seen a long outperformance of growth investing. There have been only brief periods when value performed better (seen when the oscillator at the bottom falls below zero).

History suggests value is due a longer period of outperformance. However, ultra-low interest rates are generally understood to be the reason that every time value has started to perform better than growth in the last 10 years, it has proven to be a false dawn. Rates probably must move up for value to comeback. What makes that tricky is that higher rates could prove to be a problem for the entire stock market. If there is a bear market, many might choose cash over value stocks.

 

Conclusion

Whether to choose growth or value investing depends on the current market outlook and your own financial goals and risk tolerance. Both investing strategies offer both opportunity and risk. Which style you choose is ultimately a personal preference.

 

 

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