Today let’s talk about two basic types of stocks for investment purposes: growth vs. value. These types of companies serve a very different purpose in your portfolio. Both (or either) can be very useful ingredients in your investing “pie” if used correctly.
Value stocks are, well, selling for a good value. That’s a rather subjective idea, but it’s a very widely used measure of companies’ stocks. Analysts compile groups of similar companies, dissect their fundamental financials, and try to identify those stocks that are trading at a relative discount. These analysts can use any form of basic or advanced metrics to determine what that “value” is and what companies are or are not trading at that discount. The concept is pretty basic. Analysts go shopping for stocks and pick the ones “on sale”.
Like everything else, the devil is in the details. By one measure a company may be selling at a significant discount, but by another, the very same stock might be extremely expensive. It may generate a high dividend but be riddled with debt. It may have fantastic cash flow but have a boatload of capital expenditures coming up. So, determining a value stock is half science, half art. Analysts are required to consider the financials of the company itself, the financials of its peers, the current economic environment, and the industry it competes in.
Growth stocks, on the other hand, sell not because of the solid financials of the company (though that is a part of the recipe), but because of the overall potential of the company to grow and succeed. To analyze the potential of a growth stock, professionals evaluate the overall capacity for a company to increase its revenue. Will its industry grow? Can it take a dominant position in that industry? Does it have a novel business plan/product/idea? Does it have the backing necessary to fund rapid growth?
Again, the devil is in the details. All those questions above are at least partially subjective. They all require some sort of educated guess about future potential, which can be murky or flat-out impossible to predict.
So, what does that all mean to you as an investor?
Value stocks are generally more stable than growth. The companies they represent are usually more mature companies that are easier to analyze. They are also usually more stable than growth companies from a share price perspective. Mature, profitable companies may be selling at a discount from time to time, but they also have more limited ability to grow on a percentage basis. These stocks are also more likely to pay a dividend as well, thus generating some sort of residual income from the investment.
Growth stocks are volatile by nature. There is at least a small amount of speculation involved in these companies’ ability to grow and the pace they can grow at. Economic conditions have dramatic effects on these stocks, as new companies or quickly growing companies need favorable conditions in which to grow.
Growth investing and value investing have very different objectives. In times of economic and market expansion, growth tends to be a leader. Environmental factors lend themselves to risk-taking and rapid growth. When the market contracts, these companies fare the worst. They are often fueled by debt or speculative investment and that dries up very quickly. Many are unable to find a path to profitability and sell or go bankrupt. In these times of downturn, value stocks tend to hold up better. Many of these companies are mature and generate cash flow necessary to remain viable even in a struggling business environment.
Recently, the threat of inflation, war, and rising interest rates have presented a pretty daunting future for growth stocks. As expected, there has been a significant shift into value as a result. Investors that don’t want to leave the stock market all-together have just started buying safer stocks. This phenomenon has happened for business cycles over the decades on a very regular basis.
Knowing the difference between these types of stocks is very important. Even within the stock market, investors can have vastly different amounts of volatility depending on their ultimate goal. Are you a growth investor? Are you a value investor? Do you know which one you are?
Stock investing includes risks, including fluctuating prices and loss of principal.
Value investments can perform differently from the market as a whole. They can remain undervalued by the market for long periods of time
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.