Growth vs. Value Stock Investing: Understanding the Differences
Investing is often categorized into value vs. growth. Here are the differences between value and growth stocks.
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Value and growth refer to two categories of stocks and the investing styles built on their differences. Often growth and value stocks and investing styles 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.
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Growth vs. value: What's the difference?
The main difference between value and growth stocks is that value stocks are companies investors think are undervalued by the market, whereas growth stocks are companies that investors think will deliver better-than-average returns.
There are also growth funds and value funds (funds are basically just baskets of stocks and other investments wrapped up in one investment product). The difference between a growth fund and a value fund is the same as it is with stocks: Value funds are filled with stocks that investors see as undervalued and growth funds are filled with stocks that investors think will outperform.
Value vs. growth stocks at a glance
Value stocks | Growth stocks | |
Price | Currently undervalued. | Currently overvalued. |
PE ratio | Generally low PE ratios. | Above-average PE ratios. |
Dividends | Generally high dividend yields. | Low dividend yields (or no dividend). |
Risk | May not appreciate as much as expected. | Relatively high volatility. |
Value investing defined
Value investors 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 such as a public relations crisis or a longer-term phenomenon such as depressed conditions within the industry.
Value 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 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.
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.
Growth investing defined
Growth investors often chase the market’s high fliers. 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.
Growth 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.
Growth stocks 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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Investing in growth and value stocks
The stock market goes through cycles of varying length that favor either growth or value strategies.
What’s an investor to do? One option is to invest in both strategies equally. Together, they add diversity to the equity side of a portfolio, offering potential for returns when either style is in favor.
Because the market goes in value-growth cycles, think about your investing strategy, and consider rebalancing periodically so your portfolio stays in your preferred allocation.
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.
Many growth stocks tend to be in tech or IT; value stocks are frequently 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. Some investors who piece together a portfolio by stock picking might stumble upon growth and value unintentionally.
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.
