Growth vs. Value Investing: Understanding the Differences

Investing is often categorized into two fundamental styles: value and growth. But it doesn’t have to be one or the other.

Anna-Louise JacksonApril 6, 2021
Growth vs. Value Investing: Understanding the Differences
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What's the difference?

Value and growth refer to two categories of stocks and the investing styles built on their differences. Value investors look for stocks they believe are undervalued by the market (value stocks), while growth investors seek stocks that they think will deliver better-than-average returns (growth stocks).

Often growth and value are pitted against each other as an either-or option. But portfolios have room for both, and finding the right blend of value stocks and growth stocks can lead to increased diversification.

» Want more diversification? Learn about index fund investing

Before you opt for a stock or mutual fund of the growth or value variety, here’s what you need to know about each school of thought, starting with a table of the major differences:

Value vs. growth stocks at a glance

Price

PE ratio

Dividends

Risk

Value stocks

Currently undervalued

Generally low PE ratios

Generally high dividend yields

May not appreciate as much

Growth stocks

Currently overvalued

Above-average PE ratios

Low or no dividend

Chance for relatively high volatility

What is value investing?

Value investors are on the hunt for hidden gems in the market: stocks with low prices but promising prospects. The reasons these stocks may be undervalued can vary widely, including a short-term event like a public relations crisis or a longer-term phenomenon like depressed conditions within the industry.

Such investors buy stocks they believe are underpriced, either within a specific industry or the market more broadly, betting the price will rebound once others catch on. Generally speaking, these stocks have low price-to-earnings ratios (a metric for valuing a company) and high dividend yields (the ratio a company pays in dividends relative to its share price). The risk? The price may not appreciate as expected. (Read up on finding good cheap stocks.)

Benjamin Graham is known as the father of value investing, and his 1949 book “The Intelligent Investor: The Definitive Book on Value Investing” is still popular today. One of Graham’s disciples is the most famous contemporary investor: Warren Buffett.

» Learn more about using PE ratio

What is growth investing?

Growth investors often chase the market’s highfliers. You’ve likely seen the disclaimer from financial companies that past performance isn’t indicative of future results. Well, this investing style is seemingly at odds with that idea.

It’s essentially doubling down: Investors bet a stock that’s already demonstrated better-than-average growth (be it earnings, revenue or some other metric) will continue to do so, making it attractive for investment. These companies typically are leaders in their respective industries; their stocks have above-average price-to-earnings ratios and may pay low (or no) dividends. But by buying at an already high price, the risk is that something unforeseen could cause the stock’s price to fall.

This style’s “father,” Thomas Rowe Price Jr., developed his philosophy in the 1930s and later went on to found the asset management firm that still bears his name: T. Rowe Price.

How growth and value investing overlap

Each school has devoted followers, but there’s a lot of overlap. Depending on the criteria used for selection, you’ll see stocks that are included in both value and growth mutual funds. What gives?

In part, it’s much ado about a distinction that’s not set in stone. For example, a stock can evolve over its lifetime from value to growth, or vice versa.

It’s also worth noting that investors in the value versus growth debate have the same goal (buy low and sell high); they’re just going about it in different ways.

Value investors look for companies that have already earned their stripes and have a stock price that’s lower than it should be (and may rise again to reflect that). Growth investors look for companies with future potential and expect the stock price to increase (even if it’s already relatively high) as the companies reach or exceed that potential. Same desired destination, different ways of getting there.

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Not an either-or decision

The stock market goes through cycles of varying length that favor either growth or value strategies. The stocks in the Russell 1000 Growth index outperformed those in the Russell 1000 Value index during the 2009-2020 bull market, but that’s not the case on a year-by-year basis. Value outpaced growth in 2016.

What’s an investor to do? One option is to invest in both strategies equally, according to John Augustine, chief investment officer at Huntington Bank. Together, they add diversity to the equity side of a portfolio, offering potential for returns when either style is in favor. A 50-50 split may also help investors avoid the temptation of chasing trends.

Investing in growth and value funds adds a layer of complexity to an investment strategy, which is why Augustine suggests it as a secondary step — after diversifying across different types of assets (like stocks and bonds) and other classifications within, such as size or region.

Because the market goes in value-growth cycles, these strategies may require a more watchful eye, especially if your portfolio doesn’t automatically rebalance. When market fluctuations shift your allocation, rebalancing brings it back to your original goal so you’re not unintentionally over- or underinvested in any asset.

Augustine suggests investors rebalance at least twice a year — “when the clocks change” — or once allocations have gotten out of whack by 5% or more.

Common misconceptions

In addition to the myth that investors must be growth or value purists, it’s also important to realize these styles often whittle down to industry. Currently, more than a third of stocks in the S&P 500 Pure Growth index are in the information technology sector, while about a third of stocks in the S&P 500 Pure Value index are in the financial sector. This breakdown makes sense: The country’s major financial institutions are far more established than the relatively new leaders in information technology.

Finally, understand that effective diversification matters more. Many investors who piece together a portfolio by stock picking stumble upon growth and value unintentionally, Augustine says.

“They’ll find some things that are out of favor and some that are in favor,” Augustine says. “That’s growth and value.”

Bought stock in a large, 100-year-old company during a market dip? That may have been a value investing move. Jumped on a pricey, hot stock that’s been soaring in recent years? You just became a growth investor. But either way, you’re buying into the stock market, betting you’ll be able to sell those shares at a higher price at a later date.