Growth vs. Value Stocks
Have you ever heard stocks being labeled as growth or value stocks and wondered what they meant? In today’s article, we will discuss what each means, how to differentiate between them, and the advantages of each:
GROWTH STOCKS
Growth stocks are companies that are expected to have high earnings growth in the future and thus are priced higher than what they are inherently worth. Typically growth stocks fall into two categories; they are small to mid-cap companies with room to expand in their current field, and they utilize new technology and ideas to gain an edge. For these reasons some sectors like the tech sector mostly comprise growth stocks.
To easily identify if the company you are looking at is a growth stock, you can always take a look at their price-to-earnings ratio (you can find this data on finance yahoo). As expected, growth stocks have a higher price-to-earnings ratio (some even have negative ones as they are incurring costs in the short term) as they are expected to do better in the future. A good benchmark to check whether their p/e ratio is relatively high is to compare it against the market average. Additionally, growth stocks typically pay no or very little dividends as they are more focused on continually expanding instead of returning the money to the investors in the short term. An example of a growth stock is Nvidia. As investors expect it to do very well in the future with it’s new ai chips, it is considered a growth stock. One thing to note is that growth stocks are also typically riskier than normal or value stocks as they are priced higher out of speculation for future earnings. As no one knows what the future will hold these stocks inherently carry more risk.
VALUE STOCKS
Value stocks are companies that are expected to have slower growth and are worth near or less than what they are intrinsically worth. Unlike growth stocks which get most of their value from growth speculation, value stocks get their value from what they are presently worth. Typically value stocks are large companies with not much room to grow in their current field and have stable earnings. For these reasons, some sectors like the industrials sector mostly comprise of value stocks
To easily identify the company you are looking at is a value stock, you can always take a look at their price-to-earnings ratio (you can find this data on finance yahoo). As expected, growth stocks have a lower price-to-earnings ratio as they are expected to do better in the future. To check whether the company’s p/e ratio is high or low, take a look at the market average. Additionally, value stocks typically pay high dividends as they typically don’t need as much capital to expand and instead return it to the shareholders. An example of a value stock is JP Morgan. As it has a relatively low pe ratio, is very stable One thing to note is that value stocks are also typically a lot less risky than normal stocks as they are known for their fair price and stable nature.
Finally, which should you pick?
Studies have revealed that in the long-term value stocks tend to outperform growth stocks (even while being a less risky asset), however in the past 10 years growth stocks have been outperforming value stocks. Something else to mention is that growth stocks tend to do better in times of economic growth (like in the past 10 years), however, in times of economic unrest, the stability and strength of value stocks make them easily outperform growth stocks. Something else to consider is that learning how to spot good value stocks is generally considered a lot easier than being able to spot good growth stocks as the latter is more speculative.