Investing in stocks is an excellent way to grow wealth. Investing in stocks provides high returns due to the power of the compounding effect. Two of the most famous approaches to investing are Value Investing and Growth Investing. Both growth and value stocks can maximize value for investors, but the 2 schools of investing take different approaches.
There have been a lot of discussions about which approach to investing will produce higher returns. For years, the battle has been going on, where both sides have provided valid arguments with supporting statistics. So let us understand the difference between the two and which approach should the investors choose.
Using the Value Investing approach, investors invest in stocks that are trading at a price lower than their book or intrinsic value. This technique was invented during the 1920s. While using the Growth Investing approach, investors invest in those stocks that show growth in their earnings; this technique was invented during the 1940s.Learn how to mange your money & create wealth, Download your FREE eBook now
Table -1 Difference between Value and Growth Approaches to investing.
Table -1 above shows the differences between the two approaches. Usually, the stocks of large and mid-cap companies are undervalued as they mature, while the small and mid-cap companies are in the growth stage and are moving towards becoming a large-cap company. Hence, growth potential is more in the companies of such stocks.
The price of growth stocks is overvalued because investors expect high growth of sales and profits in the future, and thus it is an expensive buy compared to the value stocks as they have strong financials but are trading at a lower price than their book value.
The risk is quite less in value investing as compared to growth as these stocks are undervalued, being established companies. Even negative news will have less effect on such stocks because they have already proven their earning potential. On the other hand, growth stocks are mostly overvalued, and if the growth plan does not materialize, then the stock price may go down.
The growth stocks’ returns may take time as the growth of such companies may take time, so the investment horizon of such shares can be longer. While the value stocks can reach near to their book value in a shorter time if the company performs well, so investment horizon of such shares can be short.
The earnings from value stocks are usually less because the stock price has already reached a level because the company is quite old. The capital appreciation would not be much, but the dividend earnings are high. In contrast, there is more capital appreciation in growth stocks because the company is growing, and the stock price will increase with the performance of the company. The dividend earnings are low because the company invests the profits back for further projects and pays a little dividend. Still, after the removal of the dividend discount tax, some companies have started paying the dividend.
Generally, value stocks have a lower Price/Earnings and Price/Book ratio than growth stocks with high P/E and P/B ratios.
Also read: 12 Rules of Value Investing
Value or Growth? Or both?
Investors ask which approach is better for investing or which would give more profits. Though some studies have proven that the value investing strategy has outperformed the growth investing approach, to be honest, there is no mantra or no proven way for making profits on the stock market. Investing is individual-centric and depends upon your personal goals, time horizon, and risk appetite. These approaches will help you invest with much more confidence and reduce your risks, but they do not guarantee profits.
Growth and value investment tend to run cyclically. Understanding both will help you decide which is beneficial for your specific goals. The style you choose does not depend upon what type of investor you are;both approaches can be helpful.
When investing for a more extended period, many investors combine value and growth stocks to minimize risks. This approach helps investors smoothen returns throughout the economic cycle where general market situations favor either the growth or value investment style.
Still, while creating a portfolio, an investor creates his style of investing. So while building your portfolio, you can keep the characteristics of both in mind but choose or make an approach that helps you achieve your goals.