One thing that beginner or even intermediate traders might have trouble grasping is the different types of stock and the philosophies on why some are more appealing than others. The basics of buying low and selling high only go so far. What are the differences between value vs growth stocks, and what do they mean for your own trading?
- Value stocks come from companies with stocks valued at less than their fundamentals.
- Growth stocks come from companies with stocks expected to grow in value.
- Value stocks are riskier but can offer higher and faster rewards, while growth stocks are more reliable.
- Value and growth stocks are different, but not opposites. In rare cases, a stock could fall into both categories.
- Most buyers focus on one of the two types, depending on their goals.
Understanding Value Stocks and Growth Stocks
To begin, it’s important to consider that publicly traded companies have different indicators called fundamentals. The fundamentals are aspects like sales, earnings, and other bedrock ways to judge how well a company is doing. Fundamentals are vital to the definition of value stocks.
A value stock company tends to trade at a lower price than what its fundamentals might suggest. In other words, despite the sales, earnings, etc. of the company being at a certain level, its stock is available at a lower price than that of other companies doing equally well. In the same way that buying a product at a major discount is a good value, the appeal of these stocks is that they can be bought for less than they’re worth. Value stocks can appear in all sorts of major industries, from banking to defense and automobiles.
The appeal of these stocks is that they offer high dividend yields and price-to-earnings ratios. Value investors look for stocks they believe are trading for less than what their company’s worth would dictate, sweeping up such a deal before things change.
Meanwhile, growth stocks come from companies that have a very strong earnings growth rate and are generally expected to remain stable in the market, regardless of any outside factors. Growth stocks are appealing to certain types of investors because they are more likely to rise, either consistently or in the short term. They are also better insulated against any market direction. Even if the market in general starts to fall, growth stocks have a chance to fall much less or even stay growing during that time.
More cautious or conservative buyers can confidently buy growth stocks and expect them to be worth more money in the future. Lots of growth stocks come from tech, healthcare, business management, and travel companies.
Value Stocks and Growth Stocks: An Analogy
To better understand, consider an example outside of stock trading.
Pete is an art trader, buying artwork to sell it later. He finds a painting that he could buy from someone. The painting was made by Artist X, a figure getting a lot of news coverage right now and who people seem to like a lot. Pete decides that a painting by Artist X will probably be worth more than what he pays for it after Artist X has grown their name. Thus, Pete buys Artist X’s painting in the hope that he can sell it in the future for more.
Mary is also an art trader. She finds a painting being sold by a failed art store liquidating its inventory. The painting is by Artist Z, a polarizing figure with a strong personality and a lot of mixed press. Sometimes, Artist Z will say or do things that either dramatically improve their reputation temporarily or create a scandal. The particular painting is priced very low, so Mary buys it in the hope that she can sell it during a potential future peak in Artist Z’s value.
In this example, Pete would be similar to a growth trader, with Artist X representing a growth stock, while Mary would be a value trader, with Artist Z representing a value stock. The growth strategy is bullish since it relates to reliably positive expectations for the stock. The value strategy is not so much about predictable expectations and more about finding good deals from volatile companies.
Differences Between Value Stocks and Growth Stocks
One important difference between growth and value stocks is that growth stocks come from companies that usually reinvest all of their earnings, and therefore do not pay dividends. While growth stocks are generally considered more conservative and safe, they could still drop in value instead of rise. With value stocks, even if the company’s general stock price under-performs, dividends can help balance out that setback.
The most fundamental difference is the philosophy behind trading these two stock types. More cautious or long-term traders like growth stocks because they value their high chance to rise in value. The actual price does not really matter much. Value stocks, on the other hand, are appealing to riskier traders who care about making the biggest difference in their trades. For a buyer, that would mean getting in at the lowest possible price and selling at the highest, and for a short seller, that would mean borrowing at the highest possible price and buying at the lowest.
These two stock types also behave differently in response to the general market. Growth stocks are more stable and consistent, whereas value stocks will fluctuate with the economy more. Value stocks tend to rise significantly when the market lifts out of a recession, and by contrast, they’re some of the first to plummet at the initial drop.
Similarities Between Value Stocks and Growth Stocks
Both value and growth stocks involve risks and speculation. Growth stocks involve speculating that a company is doing well and will grow their capital over time. Value stocks involve buying in to a currently undervalued stock and selling at a sudden peak in price. In either case, predictions are being made and there are no guarantees.
You might expect that growth stocks are a wiser choice in general, and that value trading is risky, but it depends on how you mean it. Studies have shown that plenty of traders get a net positive over long-term value trading. There are simply more variables taken into account and more effort thrown toward maximizing the value of every trade. That can make value trading better than growth trading or worse, depending on your strengths and weaknesses as an investor.
You might be wondering, are there stocks on the market that qualify as both value and growth? The answer is yes, but they’re rare. To understand why, imagine that situation. The stock turns out to be undervalued for those who calculate it, but also has a strong indication of growth. Those who see the stock and how it’s growing will buy it, raising the price until it is no longer a value stock.
Still, a combined value and growth stock does happen sometimes, but it will take thorough research and the willingness to act fast in order to make money on them. In general, you’re better off choosing one of the two types and researching the best stocks you can.
Value Vs. Growth Stocks: Which to Focus on?
Whether value or growth stocks will better fit your portfolio depends on your investing interests. People who choose growth stocks tend to enjoy betting on a company that they expect to grow and do better. Thus, people who have a good eye for a particular industry will often buy growth stocks in that industry for companies they have good reason to believe in based on experience or deeper knowledge. If that sounds like you, consider growth stocks.
Value stocks take an arguably cynical outlook. At the least, they are more focused on individual companies and their histories. A value trader will consider a company whose stock interests them and then look over financial statements to judge the calculated value. If the calculated value is higher than the current stock price by enough of a margin, the investor will buy it. If you can endure more risk and don’t focus on a particular industry, consider value stocks.
Just keep in mind: the decision is not cut and dry, and you have no obligation to pick one and forever ignore the other.
The Promise of Growth or the Lure of a Deal
Now that you understand value versus growth stocks, all you have to do is consider your own investing goals and which type best suits you. It’s rare to find a stock that qualifies as both value and growth at the same time, so you’ll have to decide which is more appealing to you and look for good examples of that type.
The difference between a failed and successful trader is the willingness to learn and discover the best strategies for them. RagingBull’s experts have put in the time and tested every strategy, and we’re here to pass that knowledge to you. Get your questions answered at our knowledge base and don’t miss the chance to get a free copy of Options Profit Accelerator before it’s gone.