You may have heard the terms growth stocks and value stocks before, but what is the difference? Is one really better than the other? First, let’s take a look at the broad characteristics of both growth and value.
At the most basic level, a value stock represents a company that is perceived as undervalued. While this can be somewhat of an arbitrary measure, it generally means the trading price is lower than what analysts believe the stock is actually worth. There are a number of potential causes for this to happen—it could be a scandal within the company even though it has strong financials, the sector or market as a whole could be down, or it might just be an offseason. Whatever the cause, value investors look for discounted prices with the hope that they will rise to where they “should” be.
Conversely, growth stocks are companies that have been, and are expected to continue growing at a faster pace than the broad market. This is often defined by high sales and earnings growth, as well as leadership in the marketplace. While value stocks often pay out dividends to investors, growth stocks tend to reinvest earnings back into the company with hopes of driving larger revenue and profit, thus also seeing an increase in the stock price.
It’s worth noting that this comparison is not always black and white. There is often overlap between stocks and funds that could categorize them as both growth and value. Sometimes companies can evolve into a value company over time as opposed to growth, or vice versa. The goal of both is largely the same (to return value to shareholders), they just provide different strategies for achieving it. From a performance standpoint though, it’s tough to pick one or the other because at different times throughout history, each has outperformed the other.
As the graph shows, there have been years (and sometimes decades) where one is better than the other. Going back to 1926, value has shown better results in a larger number of years, but growth experienced its prolonged periods of dominance as well, such as the most recent bull market coming out of the 2008 financial crisis.
Looking beyond only returns can help provide more clarity. A strategy can and should take into additional considerations such as time horizon, risk tolerance, and diversification. If an individual wants potentially more stability and an income generating option, then value could be the route to take. If an individual can deal with more volatility and has the time to wait for potential capital appreciation, then growth could make sense. Without being able to predict the future though, a safe bet is to have a mix of both. Combining the investment styles creates more diversification for a more holistic portfolio, helping it to partake in the benefits of both options while leveling out some risk.
Ultimately, whatever fits best into an investor’s plan based on his or her needs and goals should be the deciding factor on whether to include a certain stock or fund. And like a company evolves, so too can an investment strategy, so the balance between growth and value can change over time.