Investing in stocks: Growth vs Value

7 March 2022
Investing in stocks: Growth vs Value

In a nutshell

Growth and value represent two alternative approaches to stock market investing. 
Growth stocks refer to companies with better-than-average earnings or revenue growth, which the market expects to continue in the future. Value stocks denote companies that have good fundamentals, but which have somewhat fallen out of favor among investors and that appear undervalued.

Growth stocks

Investors expect to see earnings/revenue growth that exceeds the market average, and these stocks often look expensive in terms of P/E ratios and show higher volatility. Investors look at growth stocks to generate capital gains through stock appreciation, as these companies generally reinvest their earnings into their business to generate faster growth, rather than pay dividends.

Value stocks

These stocks refer to companies that appear to be cheap when looking at their fundamentals or against other companies in the same industry, and can often offer high dividend yields. They are generally perceived to be less risky than growth stocks, but that is by no means guaranteed.

Growth

As a general rule, growth stocks are a good choice if you don’t need ongoing income from your portfolio, you have a long term horizon and you can stomach wider swings in prices. Many growth stocks see their prices soar as investors are excited about their prospects, but if expectations don’t materialize prices can plummet just as fast. And sometimes such expectations are just so unrealistic that a correction may be inevitable. At its peak in November 2021, Tesla’s market cap reached US$ 1.2 trillion (higher than the next ten largest auto makers combined, despite selling 1/50th of the cars), implying a market share of 60%+ of the entire global passenger EV market and a level of profitability higher than Apple’s, by 2030. But be careful before betting on a price correction: growth stocks can sustain unrealistic valuations for prolonged periods of time, as many investors who shorted Tesla’s stock have witnessed, time and time again.

Value

On the other hand, if you are investing in stocks looking for dividends to complement your income, value stocks are a more obvious choice: given the lack of evident growth opportunities, these companies tend to pay out larger portions of their net cash flows through dividends. And as long as business conditions remain predictable, price volatility is comparatively lower. These stocks are generally perceived to carry a lower risk, but there is a catch. When is a stock actually cheap? It may well be that a company is trading at a discount to its industry peers for good reasons: it may have lost its competitive edge, it may not be able to keep up with innovation or industry-wide changes. In that case, a lower price may well be permanent. And if you picked one of these companies, you will have fallen into the so-called “value trap”: not much joy will come from owning that stock.

Stocks, but also ETFs

One can invest in growth and value stocks individually, or they can elect to pick mutual funds or ETFs that invest in either, across one or more geographies and currencies. Or they can pick a mix of both, choosing funds that invest in growth as well as value, following a strategy known as “growth at a reasonable price” (GARP). 

What’s best?

But is it possible to say more about their relative risk or chances of over-performance? Not really.

There will be periods when growth stocks are less risky than value stocks. There is no law stating that value will always be safer than growth, or that growth will always outperform value.” (Source: etftrends.com)

Despite growth having dramatically outperformed value since the Financial Crisis (as shown in the graph above), in the last year the trend has reversed. But it’s anyone’s guess whether this will continue to be the case for the next one, three or ten years.  

Source: etftrends.com, Canterbury Investment Management

Whether you choose value or you prefer growth stocks, tracking your portfolio performance is – as always – of paramount importance. If you are not registered yet, visit Exirio to create your free account and start tracking everything you own.

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