Growth vs. Value: What's the Difference?
With the wide variety of stocks in the market, figuring out
which ones you want to invest in can be a challenging task. Many investors feel
it's useful to have a system for finding stocks that might be worth buying, deciding
what price to pay, and identifying when a stock should be sold. Bull
markets — periods in which prices as a group tend to rise — and bear
markets — periods of declining prices — can lead investors to make irrational
choices. Having objective criteria for buying and selling can help you avoid
Even if you don't want to select stocks yourself — and many
people would much prefer to have a professional do the work of researching
specific investments — it can be helpful to understand the concepts that
professionals use in evaluating and buying stocks.
There are generally two schools of thought about how to
choose stocks that may be worth investing in. Value investors generally buy
stocks that appear to be bargains relative to the company's intrinsic worth.
Growth investors prefer companies that are growing quickly, and are less
concerned with undervalued companies than with finding companies and industries
that have the greatest potential for appreciation in share price. Either
approach can help you better understand just what you're buying — and why — when
you choose a stock for your portfolio.
|Relatively low P/E ratio
||High P/E ratio
|Low price-to-book ratio
||High price-to-book ratio
|Relatively slow earnings growth
||Rapid earnings growth
|High dividend yield
||Low or no dividend yield
|Sluggish sales growth
||Rapid sales growth
Value investors look for stocks with share prices that don't
fully reflect the value of the companies, and that are effectively trading at a
discount to their true worth. A stock can have a low valuation for many
reasons. The company may be struggling with business challenges such as legal
problems, management difficulties, or tough competition. It might be in an
industry that is currently out of favor with investors. It may be having
difficulty expanding. It may have fallen on hard times. Or it could simply have
been overlooked by other investors.
A value investor believes that eventually the share price
will rise to reflect what he or she perceives as the stock's fair value. Value
investing takes into account a company's prospects, but is equally focused on
whether it's a good buy. A stock's price-earnings (P/E) ratio — its share price
divided by its earnings per share — is of particular interest to a value
investor, as are the price-to-sales ratio, the dividend yield, the
price-to-book ratio, and the rate of sales growth.
Here are some of the questions a value investor might ask
about a company:
- What would the company be worth if all its assets were
- Does the company have hidden assets the market is
- What would the business be worth if another company
- Does the company have intangible assets, such as a high
level of brand-name recognition, strong new management, or dominance in its
- Is the company on the verge of a turnaround?
Contrarians: marching to a different drummer
A contrarian investor is one example of a
value investor. Contrarians believe that the best way to invest is to buy when
no one else wants to, or to focus on stocks or industries that are temporarily
out of favor with the market.
The challenge for any value investor, of course, is figuring
out how to tell the difference between a company that is undervalued and one
whose stock price is low for good reason. Value investors who do their own
stock research typically comb the company's financial reports, looking for clues about
the company's management, operations, products, and services.
A growth-oriented investor looks for companies that are
expanding rapidly. Stocks of newer companies in emerging industries are often
especially attractive to growth investors because of their greater potential
for expansion and price appreciation despite the higher risks involved. A
growth investor would give more weight to increases in a stock's sales per
share or earnings per share (EPS) than to its P/E ratio, which may be
irrelevant for a company that has yet to produce any meaningful profits.
However, some growth investors are more sensitive to a stock's valuation and
look for what's called "Growth At a Reasonable Price" (GARP). A growth
investor's challenge is to avoid overpaying for a stock in anticipation of
earnings that eventually prove disappointing.
A growth investor might ask some of these questions about a
- Has the stock's price been rising recently?
- Is the stock reaching new highs?
- Are sales and earnings per share accelerating from quarter
to quarter and year to year?
- Is the volume of trading in the stock rising or falling?
- Is there a recent or impending announcement from or about
the company that might generate investor interest?
- Is the industry going up as a whole?
Momentum investing: growth to the max
A momentum investor generally looks not just for growth but for
accelerating growth that is attracting a lot of investors and causing the share
price to rise. Momentum investors believe you should buy a stock only when
earnings growth is accelerating and the price is moving up. They often buy even
when a stock is richly valued, assuming that the stock's price will go even
higher. If a stock falls, momentum theory suggests that you sell it quickly to
prevent further losses, then buy more of what's working.
Some momentum investors may
hold a stock for only a few minutes or hours then sell before the market closes
that day. Momentum investing obviously requires frequent monitoring of the
fluctuations in each of your stock holdings, however. A momentum strategy is
best suited to investors who are prepared to invest the time necessary to be
aware of those price changes. The risk of loss from this type of trading strategy can be substantial. You should therefore consider whether such a strategy is suitable for you based on your individual circumstances and financial resources.
Why understand investing styles?
Growth stocks and value stocks often alternate in
popularity. One style may be favored for a while but then give way to the
other. Also, a company can be a growth stock at one point and later become a
value stock. Some investors buy both types, so their portfolio has the
potential to benefit regardless of which is doing better at any given time.
Investing based on data rather than stock tips or guesswork can not only assist
you as you evaluate a possible purchase; it also can help you decide when to sell
because your reasons for buying are no longer valid.