Growth stocks vs. value stocks

Value investing is one of the main types of investment strategy employed by investors all around the globe. In this article, we’ll explore the concept of value stocks and how they compare to growth stocks. We’ll also discuss the advantages and disadvantages of each, their behaviour during times of economic uncertainty and high-interest rates, and the two primary ways to invest in both types of stocks. Finally, we’ll provide some examples of these stocks.

What are value stocks or value investing?

Value stocks or value investing is a philosophy developed by Benjamin Graham and David Dodd, who were professors at Columbia Business School. These stocks trade below their intrinsic value and often even their book value.

The core principle of value investing is to identify stocks that are undervalued based on their fundamental indicators. Investors who follow this philosophy patiently wait for the market to recognise and correct the undervaluation over the medium to long term.

The key aspect is analysing companies to determine their intrinsic value and comparing it to their current market price. The goal is to invest in stocks that are trading at a discount to their intrinsic value, allowing for significant potential appreciation.

To achieve this, value investors take advantage of short-term market fluctuations with a long-term perspective. They aim to acquire shares of well-established, financially sound, dependable, and undervalued companies at attractive prices.

What are growth stocks?

Growth stocks are companies that offer substantial growth potential in a relatively short period. They attract many investors because of the expectations for future profits.

These companies are often associated with entrepreneurship and startups. They are typically newly established and in a phase of rapid expansion. Instead of distributing dividends to shareholders, they reinvest their profits back into the business. This reinvestment, coupled with their innovative nature, fuels high expectations for their growth in the market.

Due to these factors, growth stocks are perceived to have significant growth potential in the stock market, often surpassing that of other types of stocks like value or performance stocks.

However, they also come with higher risk. They are not suitable for conservative investors due to their greater price volatility and fluctuation. While the potential for substantial appreciation is high, there is the risk of losing some or all of the invested capital. Therefore, they are best suited for investors with a healthy appetite for risk.

Benefits of value stocks vs. growth stocks

Let’s compare the advantages of value stocks and growth stocks in the following table:

Advantages of value stocks

• Profitability: Value stocks historically have shown good returns.
• Capital: You don’t need a large initial investment as these value stocks tend to have low stock prices. Even a small amount, coupled with time, reinvested dividends, and compound interest, can yield substantial returns over the long term.
• Time horizon: Value investing typically has a long-term focus, which means you’re less affected by short-term market fluctuations, news, data, and rumours.
• Peace of mind: There’s no need to constantly monitor your portfolio since short-term price fluctuations don’t significantly impact value stocks.
• Diversification: With less capital required, you can invest in multiple companies, achieving proper diversification across geographical areas or sectors.
• Commissions: Because value investing involves fewer frequent buy-sell transactions, commission expenses with brokers are minimal.

Advantages of growth stocks

• High revaluation potential: Growth stocks offer the potential for significant short-term appreciation, often surpassing that of other investment types.
• Short time horizon: These investments are geared toward relatively quick returns, making them suitable for investors seeking shorter-term opportunities.
• Emerging markets: Growth stocks often involve investments in emerging companies from niche markets, which have the potential to disrupt established industries.

Risks of value stocks vs. growth stocks

Now, let’s examine the risks associated with both value stocks and growth stocks:

Risks of value stocks:

• Discipline: Maintaining value stocks in your portfolio for an extended period can be challenging. It’s not easy to hold onto these stocks, whether they are losing value or generating capital gains. The temptation to sell can be persistent.
• Knowledge: Determining the intrinsic value of a stock is a complex task that requires specific training and expertise.
• Monitoring: It’s essential to continuously monitor the fundamentals of the stocks in your portfolio. Significant changes may require a shift in your investment strategy.

Risks of growth stocks:

• High risk: Growth stocks are associated with substantial risk due to their extreme price volatility. However, this risk is often balanced by the potential for significant appreciation.
• Information requirements: Investing in growth stocks demands in-depth knowledge of the companies you’re considering. Understanding all aspects of these businesses is crucial.
• Short-term volatility: Growth stocks can experience significant price fluctuations in the short term. Market noise and investor sentiment can contribute to this volatility.

Check out our comprehensive guide on how to invest in the stock market. It provides valuable insights for those planning their first investment in stocks.

How do value stocks and growth stocks behave in an uncertain economic environment?

Let’s explore how both value and growth investments respond in uncertain economic conditions:

High interest rates

Generally, increases in interest rates are not favourable for the stock market as a whole, with some exceptions in sectors like finance (including banking and insurance). However, it’s important to note that the technology sector, where many growth stocks reside, tends to suffer the most when interest rates rise.

On the other hand, value stocks, apart from the financial sector, are less negatively impacted by interest rate hikes due to their long-term investment nature.

Economic uncertainty

Periods of economic uncertainty typically have a negative impact on stocks in general, except for those known as defensive stocks. In the case of value stocks, a drop in their price, while maintaining strong fundamentals, often presents an attractive buying opportunity.

How to invest in value stocks

There are two primary ways to invest in value stocks:

Buy value stocks

This approach involves selecting and purchasing individual company shares to create a stock portfolio. When adopting this strategy, consider the following aspects:

• Price-to-earnings (P/E) ratio: This ratio measures a stock’s price relative to its earnings. Lower P/E values indicate that a stock may be undervalued.
• Market capitalisation: Many investors target companies with a market value of less than $1 billion, as they may offer greater potential for business growth.
• Dividend yield: The dividend yield helps assess a company’s ability to generate value for its shareholders, as dividends play a significant role in value investing.

Learn more about dividends and how to identify the best dividend stocks in the UK to invest in.

Investing in ETFs

The second option is to invest in funds whose strategy focus on value investing. Here are some examples of ETFs that invest in value stocks:

How to invest in growth stocks

Similar to value stocks, there are two primary approaches to investing in growth stocks:

1. Purchasing individual stocks of growth companies.
2. Investing in ETFs that focus on growth stocks.

Here are some noteworthy options:

Examples of value stocks vs. growth stocks

In the chart below, you’ll find a comparison of the returns generated by these two types of stocks over the past 29 years.

Some examples of value stocks:

Examples of growth stocks:

Read more about investment strategies

• Long-term investment strategies
• Markowitz model
• Hedging
• How to create a stock portfolio
• Dividend investing

Summary

In conclusion, understanding the dynamics of value and growth stocks is essential for any investor. Value stocks, with their emphasis on long-term stability and undervalued assets, appeal to those seeking reliability and patience. On the other hand, growth stocks, characterised by their potential for rapid appreciation and innovation, attract those with a higher risk tolerance and shorter investment horizons.

Both options have their benefits and drawbacks, and their performance can be influenced by economic conditions. Whether you choose value or growth stocks, a well-informed strategy that aligns with your financial goals and risk tolerance is key to achieving success in the dynamic world of stock investing.

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