Two terms you hear tossed around are Value Investing vs Growth Investing. What are the differences? Which is riskier? Here is a look at both, along with their pros and cons, to help you decide which strategy is right for you.
That key word to latch onto here is “value.” As an investment strategy, value investing involves purchasing stocks that appear to be currently trading for less than their book or intrinsic value.
Value investing involves looking for stocks that the stock market is underestimating in terms of value, according to Investopedia.
Value investors believe that some stocks are undervalued when the market overreacts to good and bad news. The stock price movements may not correspond to the long-term fundamentals of a particular company.
Therefore, the market overreaction lowers the price of a company’s stock, presenting an opportunity to purchase that stock at a lower value that investors believe will increase over time.
Some of the most well-known value investors include Warren Buffett, his professor and mentor Benjamin Graham, and his close partner Charlie Munger, to name a few.
Growth investing, quite simply, is seeking out stocks that investors believe will deliver better-than-average returns, according to Nerdwallet.
The strategy often involves investing in small or young companies that are expected to see their earnings increase at an above-average rate compared to their industry sector or the overall market, according to Investopedia.
There are five key factors growth investors look for when evaluating stocks: profit margins, returns on equity, share price performance, and historical and future earnings growth.
Typically, growth investors look toward rapidly expanding industries and sometimes entire markets where new services or new technologies are being developed.
As opposed to returns from dividends, growth investors look for profits through capital appreciation – the gains they’ll receive when they sell the stock. Most growth-stock companies don’t pay shareholder dividends and instead reinvest the earnings back into the business.
More recent data comparing the performance of growth versus value stocks, during the decade of 2000-2010, value stocks outperformed growth stocks. However, in the last decade (2010-2020), growth stocks have outperformed value stocks. Experts say that dividends have likely played a key role in previously helping value stocks outperform over longer periods of time, Investopedia reported.
Value stocks are considered riskier than growth stocks. Why? The market attitude toward a particular stock is what created its lower value in the first place. Therefore, for a value stock to turn profitable, it requires that the market’s perception of the stock improve. A value stock may need a significant period of time before it rebounds from its undervalued position. The risk is that this transformation may never occur.