Are Growth Stocks and Value Stocks Similar?
A lthough growth and value stocks don’t have a hard definition, stock traders agree on a general set of conditions that differentiate these two investment terms. When looking at which stocks to trade, it’s important to have an understanding of these concepts. By getting to know these and other key stock market terms, you can be a more informed investor. Let’s further discuss growth stocks and value stocks and explore if they’re similar.
- Growth stocks are shares in a company that has had above-average earnings in the last few years and are anticipated to continue to grow at this rate, while value stocks are shares that trade at a lower price than what the company’s earnings, sales, and dividends, and overall performance may indicate.
- Growth stocks are overvalued because they have a high price-to-earnings ratio, while value stocks are undervalued because they tend to go unnoticed by the market.
- Growth stocks perform better when interest rates fall and company earnings rise, but investors may take a hit when the economy downturns. Value stocks perform better during the early stages of an economic recovery but may see losses when stock prices rise.
Growth Stock Definition
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Growth stocks belong to companies that have had above-average earnings in the past few years and are expected to continue this increasing trajectory. Investors need to be mindful that even if a stock promises high earnings, there is no guarantee such growth will happen. You may also hear about emerging growth stocks, which are companies that have the potential to achieve high earnings and a lot of growth but have not established a history of doing so.
When determining if a stock is growing, it may have the following characteristics:
- High prices: Many growth stocks sit at higher prices than the broader market. That’s because investors are willing to pay high prices if they expect a company to continue to grow.
- High earnings: Companies with growth stocks have records of growth throughout their lifetime. Even during economic downturns, they may continue to achieve high earnings growth.
- High volatility: A risk investors take with growth stocks is a sharp dip in price. When a high-priced stock falls, it can fall hard. This could be a result of negative news about the company or less-than-exciting earnings in the market.
How Investors Choose Growth Stocks
Investors may choose growth stocks since they are expected to outpace similar companies in both earnings and stock performance. Even though growth stocks tend to have lousy dividends (or no dividends at all), their potential return may be well worth it. Likewise, once a growing company becomes well established, it could eventually decide to start paying dividends. When deciding which companies have growth potential, investors consider the following factors:
When investors are looking for good growth stocks to choose, they look to the leadership. When you can see that a company has strong management that focuses on profit and growth, it’s likely that the company will continue to do well. Looking for key innovators who are making a splash in their industry is one way investors decide which stocks to buy.
Another factor growth investors look at is the target market of the company. Although niche companies can do well, growth companies tend to cater to a larger, broader audience. The more potential customers a company can reach, the more they can expand its profits. For instance, virtually everyone has a smartphone in their pocket. Companies like Apple and Samsung found a way to virtually reach a big portion of the world market, allowing them to grow substantially.
Growth in Sales
Once a company has established a strong history of sales, it may be considered a growth stock. Investors look for companies that have had rapid growth in sales in a short period of time. The more a company grows in sales, the more likely that its stock will rise too. For many investors, their criteria are double- or triple-digit growth.
Value Stock Definition
When a company’s shares hit a low, they may be considered value stocks. These often belong to companies that have had their prices fall, yet they still have a solid core. In addition to these types of companies, value stocks may belong to new companies that haven’t been recognized by investors quite yet. Think of a value stock as a bargain for a stock that has the potential for rapid growth. Investors look to buy value stocks before the market realizes just how valuable they are and fixes the price of the stock.
When determining if it’s a value stock, it may have the following characteristics:
- Low price: The purpose of value investing is to hit a stock when it’s low in price with the hopes that it will eventually rise again. Once its true value is noticed by other investors, those who invested early can make high earnings.
- Lower price than similar companies: If you notice a stock’s price is lower than that of similar companies in the same industry, this could be due to investors overreacting to sudden company news. For instance, you may see a stock take a dip after low earnings, bad publicity, or legal problems. Value investors believe such downturns are only temporary and capitalize on them.
- Have less risk: Long-term investors are willing to wait for a value stock to rise again. Keep in mind that they may have a higher chance of price fluctuation than growth stocks.
- High dividends: Having a history of high, reliable dividends shows an investor that a company is on a steady course.
- Older company: Even if a company isn’t as innovative as it once was, it may be well established enough to stick around for a long time.
How Investors Choose Value Stocks
Those who buy value stocks often go against the grain of the market. Many investors see them as outliers since they tend to reject the overall trend of the market. When choosing a value stock, such investors consider the following factors:
Value investors stay away from trendy stocks because they tend to be overpriced due to demand. They tend to invest in unknown companies that haven’t established much of a market presence yet. If they do decide to invest in a well-known company, that’s because the company’s stock took a nosedive. The idea is that this stock will rise once again, leading to big returns.
Intrinsic value is the perceived inherent value of a stock. It’s basically what an investor thinks a stock truly is, which is a portion of company ownership. Value investors choose companies that have principals and values that align with their own. Likewise, these companies have solid finances despite what the market may otherwise indicate.
Growth Stocks vs. Value Stocks
Although growth stocks and value stocks may seem quite similar, they do have a few key differences. Growth stocks tend to appear overvalued, while value stocks are undervalued by the market. The reason growth stocks tend to have high prices is because of their potential for strong, rapid growth. They tend to have high price-to-earnings (P/E) ratios due to this. Value stocks tend to go unnoticed by the broad market, which leaves their prices low.
Due to these differences, many investors choose to buy growth and value stocks to diversify their portfolios. If an investor feels strongly about the direction of a particular stock or how a company will grow, they will choose to be more growth- or value-oriented.
Which Type of Investment Is Better?
When looking at growth and value stocks over history, certain patterns emerge. Growth stocks have shown to perform better when interest rates fall while company earnings rise. However, investors have been scorned when the economy has taken a downturn. Value stocks tend to do well in the early stages of an economic recovery, but also may begin to experience losses when stock prices begin to rise.
Each type of investor has many arguments for whether growth or value investing is better. Studies have shown that on a value-adjusted basis, value stocks did better than growth stocks over long periods of time. For short-term investors, value stocks may be a better choice since this fleeting focus can lower stock prices.
When choosing which type of stock to invest it, you may discover that one suits your investment style better than the other. The key thing to remember is that both growth and value stocks offer a lot of potential, but both come with risks. Doing your research before trading stocks is at the heart of making savvy investment decisions.