When it comes to investing, one might find themselves contemplating between growth stocks and value stocks. Each comes with its own set of pros and cons, and can play a significant role in overall investment strategy, depending on specific goals. Let’s break down the fundamental differences between the two.
Growth stocks are shares expected to increase in value and outperform the market, promising higher-than-average returns over the long term. These stocks typically belong to businesses or industries poised for expansion. However, these stocks come at a premium due to their strong potential to outperform.
“Growth stocks exhibit strong potential to outperform, primarily due to prospects for robust earnings growth,” explains Kevin Gordon, senior investment strategist at Charles Schwab. “They’re often considered ‘high fliers’ given their significant outperformance at times. However, they bear elevated risk during a downturn.”
On the other hand, value stocks are shares of companies deemed undervalued for various reasons. Consequently, these stocks trade at a discount relative to the company’s assets.
“Value stocks trade below their intrinsic value, often seen as hidden gems in the market,” Gordon says. “Many value stocks are tied to the economic cycle, performing well when a recession ends and a new cycle begins.”
Understanding Growth Stocks
A growth stock is a share of a company expected to grow at a rate higher than the market average. These companies generally prioritize rapid expansion, whether through increasing revenues, developing new products, or expanding market share.
However, growth stocks tend to be expensive. Their share price is typically high when compared to current earnings. These stocks are also riskier as there’s no guarantee of future success.
Pros and Cons of Growth Stocks
Pros
- May Outperform the Market: Growth stocks are expected to grow at a rate higher than the market average.
- Capital Gains: These stocks are expected to appreciate over time, providing capital gains upon sale.
Cons
- Expensive: Growth stocks are typically high-priced relative to their current earnings.
- Higher Risk: These stocks can be volatile and may crash, which can be costly given their high purchase price.
- No Short-term Returns: Growth stocks require patience as they take time to appreciate in value.
Understanding Value Stocks
A value stock is any share of a company trading below its perceived intrinsic value. “Value-oriented businesses are typically older, established entities with proven success records,” says Gordon. Companies like Target, Exxon, and Bank of America are examples of value stocks. These companies typically prioritize free cash flow and return profits to investors, providing income in the form of dividends or share buybacks.
Pros and Cons of Value Stocks
Pros
- Provide Income: Value stocks may provide near-term income in the form of dividends.
- Undervalued: These stocks are underpriced or relatively inexpensive when compared to the company’s perceived value.
- Less Volatile: Value stocks are usually more established companies that provide protection in a bear market.
Cons
- Take Longer to Appreciate: Value stocks may take several years to appreciate and thus require patience.
- Potential Dead End: There is no guarantee that value stocks will appreciate in value.
- Challenging to Identify: Finding a true value stock, one that is undervalued and may appreciate post-market correction, requires an experienced investor.
Making the Choice
Assembling portfolio assets is a highly personal decision, based on short and long-term goals, risk tolerance, and other financial needs. Growth stocks are often more volatile, expensive, and take time to reach their full potential, making them suitable for long-term financial goals. Value stocks, on the other hand, are more consistent, less risky, and often provide a good choice for earning higher short-term income.
However, one doesn’t necessarily have to choose one to the exclusion of the other. Some experts suggest a well-diversified investment portfolio will include a balance of both.
“A winning portfolio includes both a long-term allocation towards outstanding growth businesses and an allocation towards less volatile, more consistent value-oriented companies,” says Joe Percoco, cofounder and co-CEO of Titan.
