Growth vs Value stocks: Differences and Similarities

In as much as these stocks have different investing styles, there is room for both stock types in portfolios as they can both be held in a balanced diversified portfolio. Investment managers refer to such equity mutual funds with a mix of growth and value stock as a blend fund.

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We will discuss each stock type individually to throw more light on them.

The net profits or earnings of growth stock companies have the potential to grow at a faster rate than the market. Hence, their stocks are expected to rise faster than the market, over time. Most times growth stocks have a high price-to-earnings (P/E) ratio, indicating that they are overvalued. These stocks are overvalued in the market because investors tend to put into account, the expected high growth rate of the company.

The issuers of growth stocks are usually new companies in the new business sectors that show potential for substantial and rapid growth. As earlier said, these companies don’t pay dividends because they are in an expansive phase. So, they prefer to reinvest their earnings into the growth of the company.

Growth stock companies may appear in any industry or sector that usually trades at a high price-to-earnings (P/E) ratio. These companies may not seem to have earnings at the time but have the potential to in the future. Hence, many small-cap stocks (shares of companies with small market capitalization), as well as penny stocks (shares of smaller companies), are considered growth stocks. Nevertheless, some larger companies may also be considered growth stock companies. Also, companies in growth sectors such as technology, biotech, etc. can issue out growth stocks.

These kinds of stocks trade at a lower price than what the performance of the company may indicate. The stock price may not complement the performance of the company. And as a result, value investors attempt to capitalize on inefficiencies in the market.

What these investors do is look for inefficiencies in the market that make such stocks of truly valuable companies to be priced less than what they’re worth. Value investors buy stocks that seem to be trading less than the company’s intrinsic or book value. They invest in these stocks because they believe the stock market is underestimating them.

Unlike growth stocks that are known to have a high price-to-earnings ratio, value stocks have a low price-to-earnings ratio as well as a low price-to-book ratio (P/B). Contrary to growth stocks that don’t pay dividends, value stocks tend to have a high dividend yield.

Difference between growth vs value investing

The reason why an investor would invest in a growth stock compared to a value stock depends on a variety of factors, risk potential and financial goals. To understand the difference between growth vs value investing, let us look at both styles of investment.

Growth investing

Growth investing is a style of investment with a strategy that is focused on increasing an investor’s capital. This style of investment entails investing in growth stock companies such as young or small companies whose earnings are expected to increase at an above-average rate. They tend to have the potential to grow faster than other companies in the same business sector or the overall market.

Growth investors anticipate that they will earn money from eventually selling the growth stocks in the future to make capital gains. These investors believe that the fast growth in profits of the company will make the company’s stock more attractive in the future, thus, having a higher price. The reason why investors go into growth investing is that they tend to get impressive returns from buying stocks in emerging companies, once the companies are successful.

Nevertheless, growth investing can be risky because these growing companies are untried and there is no actual guarantee for success. More so, since most growth stocks don’t offer dividends, the only way investors earn money from growth investing is to sell the stocks. Therefore, in a situation whereby the company doesn’t succeed, the investors take a loss on the stock when he chooses to sell it.

Value Investing

Value investing is a style of investment with a strategy that is focused on buying stocks that seem to be trading less than the company’s intrinsic or book value. Value investors believe the stock market is underestimating these stocks and so take advantage of the inefficiencies in the market.

These investors believe that the market overreacts to good and bad news, which results in changes in the stock price. Thus, causing a stock price value that doesn’t correspond to the long-term fundamentals of a company. The concept behind value investing is to take advantage of the overreaction of the market to make a profit by buying the stocks that have been put on sale at discounted prices. There are so many known value investors such as Charlie Munger, Warren Buffet, Benjamin Graham, etc.

Differences between growth vs value stocks

1. The difference between investing in growth stock vs value stock is that growth investing focuses on buying stocks of companies that have the potential to grow at a rate that is faster than the average growth for the market, whereas value investing focuses on buying stocks that are trading lesser than the company’s intrinsic value.
2. The market value of growth vs value stocks varies in the stock market. Growth stocks are said to be overvalued while value stocks are undervalued in the market.
3. The price to book value ratio (P/B) of growth stocks tends to be above 1.0, whereas the P/B of value stocks are usually under 1.0.
4. The price-to-earnings ratio of growth stocks vs value stocks differs. Growth stocks tend to have a high price-to-earnings (P/E) ratio, whereas the P/E ratio of value stocks is low.
5. The majority of growth stocks don’t pay dividends or have a low dividend yield, whereas value stocks have a high dividend yield.

Growth vs value stocks examples

The examples of companies issuing out growth stocks vs value stocks come from several sectors. Growth stock companies are usually newer and small-cap companies. They can also be companies in growth sectors such as technology, consumer discretionary, biotech, etc. Value stocks companies, on the other hand, are usually companies in sectors such as industrials, financials, energy, and consumer staples that are probably trading their stocks at a discount to their intrinsic value.

Here is a table showing value vs growth stocks examples:

Bank of America recently listed the above-mentioned examples as its ‘Growth 10’ best growth stocks and top value stock picks as of May 24, 2022, and May 19, 2022, respectively.

Value vs growth stocks: which is better?

Theoretically, value stocks are considered to be associated with a lower level of volatility and risk. This is because they are usually stocks from larger, more established companies. So, whether or not, they return to the target price that investors and analysts predict, they may still render some capital growth. Moreso, they also pay dividends.

Growth stocks, on the other hand, usually desist from dividends payout and will rather reinvest back their retained earnings into the company for growth. The likelihood of investors running a loss on growth stocks can be greater, especially if the company is unable to keep up with the fast growth rate that is expected of it. Generally, for investors, growth stocks have the highest potential reward as well as risk.

Growth vs value stocks performance

Investors are usually curious about which investment strategy would generate more returns. As a result, there are comparisons between the growth vs value stocks’ performance in the different phases of market cycles. The performance of growth vs value stocks in recession has historically had its fair share of ups and downs.

Over the longer term, value stocks have outperformed growth stocks. But over the last 15 years, growth stocks have handily been outperforming value stocks. However, market cyclicality plays an important role when comparing the performance of growth stock vs value stock. During bull markets, growth stocks tend to perform better, as well as when corporate earnings are trending up and interest rates are falling. But during economic slowdowns, these stocks tend to lag behind as value stocks outperform them.

During an economic recession or bear market, value stocks usually outperform growth stocks. They also perform better during the early stages of an economic recovery. For example, is the recent fall and rise in long-term treasury bond rates. Due to the rise in interest rates and increasing discounts on future cash flows, investors are likely to switch from growth investing to less risky or speculative assets like fixed income and value stocks.

Growth vs value stocks’ historical performance

From more recent data, value stocks outperformed for the first 10 years of the 2000s, but over the last 10 years, growth stocks have outperformed. Moreso, the dividend that value stocks may play a key role in helping them outperform over longer periods.

Back in 1926, value stocks had numerous periods of outperformance relative to growth. But now, over the last decade, growth stocks have reigned despite the long-term outperformance of value stocks. This is one of the reasons why the S&P 500 is comprised of roughly 40% technology stocks (growth stocks). However, when it comes to comparing growth vs value stocks’ historical performance, any result seen must be evaluated based on the amount of volatility and time horizon, as well as the risk that was endured to achieve them.

Growth vs value stocks’ performance in earnings growth

In periods of broad earnings growth, the growth vs value stocks performance varies. During periods of broad earnings growth, value stocks tend to outperform growth stocks. The earnings of value stocks over the years have been seen to grow. The reverse is the case for growth stocks, most especially covid beneficiaries that have already made use of future earnings growth.

Recently, stocks from traditional value sectors like autos, financials and basic resources, have seen far superior earnings compared to the growth sectors such as software and media.

Growth stocks that were initially considered invincible, now show that they too are subject to forces like intense competition, saturated markets, supply constraints, and demanding customers. Due to the great promises associated with growth stocks, they are rewarded with high valuations. However, investors are ruthless should these companies disappoint.

Value stock vs growth stock book to market ratio

In differentiating between value stock vs growth stock, a book to market ratio can come in handy. The book-to-market ratio is used to identify undervalued or overvalued securities. This is done by dividing the book value of the company by the market value. The book-to-market ratio determines the market value of a company relative to its actual worth. So, analysts and investors use this comparison ratio to differentiate between the actual value of a publicly-traded company and the speculation of an investor.

It indicates the value of a company as it compares the company’s book value to its market value. There is a difference between the value stock vs growth stock book-to-market ratio. Stocks that have a high book-to-market ratio are referred to as value stocks. They earn significant positive excess returns. Whereas, stocks that have a low book-to-market ratio are referred to as growth stocks. These stocks earn significant negative excess returns.

Value investors prefer a high book-to-market ratio as it is an interpretation of an undervalued stock (value stock) that is trading at a discount price in the market compared to the book value of the company.

A book-to-market ratio that falls below 1 implies that investors are willing to pay more than what the company’s net assets are worth. It also indicates that the company has healthy profit projections for the future.

Hence, investors are willing to pay a premium for these possible future profit projections. Companies in industries that don’t have plenty of physical assets and technology companies tend to have a low book-to-market ratio.

Similarities between growth and value stocks

1. Growth and value stocks are both types of stocks.
2. They are traded in the stock market.
3. Growth and value stocks can be good or risky investments.
4. They can both be found on the S&P 500

Conclusion

Growth stocks are issued by companies with strong anticipated growth potential, whereas value stocks are sold at a price that is lesser than the company’s intrinsic value. The choice of investing in growth stock or value stock is left entirely to the investor’s preference. Investors that prefer to purchase stocks of companies that have the potential to grow at a rate that is faster than the average growth for the market can invest in growth stocks. Whereas, investors that prefer to buy stocks that are trading lesser than the company’s intrinsic value can invest in value stocks.

In as much as these two types of stocks have different investing styles, there is room for them both in portfolios. They can both be held in a balanced diversified portfolio. However, the preference of an investor, as well as his/her investment goals, personal risk tolerance and time horizon, will determine whether to invest in a value or growth stock.

However, one should keep in mind that the performance of growth or value stocks over shorter periods will depend to a large extent, on the phase of the cycle that the market happens to be in. Value stocks will outperform during bear markets and economic recessions. Whereas growth stocks will outperform during periods of economic expansion or bull markets. Hence, this factor should be taken into consideration by short-term investors or those seeking to time the markets.