Value vs. Growth Stocks: Which Category Is Better for Your Portfolio?
March 4, 2022
Value vs. Growth Stocks: Which Category Is Better for Your Portfolio?
March 4, 2022
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The common question—and debate—among stock market investors: Is growth investing or value investing better for your portfolio?
Whether growth or value outperforms depends solely on the time period evaluated—historically, shorter time periods tend to favor growth in recent years while longer time periods tend to favor value stocks. According to Forbes, value investing has returned 1,344,600% since 1926, while growth investing returned just 626,600% in the same period. But there’s more to the story than that: Since the 2008–2009 financial crisis, growth investing has beaten value investing. “Ultimately, what matters to investors is not the relative returns over the past decade or past century. What matters are the relative returns over an investor’s time horizon. On that basis, predicting a winner is impossible, suggesting that a blend of value and growth may be the best option.” Let’s dive into the differences between value vs. growth stocks and investing and how you can determine which is right for you.
What Are Value and Growth Stocks?
Value and growth stocks are two stock categories with investing styles based on and built around their differences. Growth stocks are companies considered capable of outperforming the overall market over time because of their future potential—their stocks’ growth rates are generally substantially higher compared to the market’s mean growth rate. They have had above-average earnings in recent years, with this growth expected to continue (though never guaranteed).
Growth stocks, also sometimes called momentum stocks, are often correctly valued or may even be slightly overvalued and often have a higher share price in the market. These are generally hot new or trendy companies and may be heavily based in the technology space. Investing in growth stocks is known as growth investing. Growth investors look for stocks that could increase in value quickly if the company’s growth continues at its current rate. Thusly, their investment’s success depends on the company’s growth and the market continuing to value these stocks at a premium. All of these factors in combination make growth stocks more volatile than the market in general.
NerdWallet states, “It’s essentially doubling down: Investors bet a stock that’s already demonstrated better-than-average growth (be it earnings, revenue or some other metric) will continue to do so, making it attractive for investment. These companies typically are leaders in their respective industries; their stocks have above-average price-to-earnings ratios and may pay low (or no) dividends. But by buying at an already high price, the risk is that something unforeseen could cause the stock’s price to fall.”
Value stocks are companies whose stocks are considered to be currently trading below their worth relative to their earnings and long-term growth potential, providing greater returns now (vs. the future potential returns of growth stocks). Value stocks are priced lower than many other stocks in the market or in their sector and inherently undervalued but with potential to grow and generate future returns. These stocks can be undervalued for a variety of reasons, “including a short-term event like a public relations crisis or a longer-term phenomenon like depressed conditions within the industry” (from NerdWallet).
Investing in value stocks is known as value investing. Value investors are buying less popular stocks while betting that the market’s opinion of these stocks will become more favorable in the future, thus increasing the stock price to closer to its actual value. These come with some risk (though generally lower than the broader market in general), as the hoped-for stock price appreciation may not materialize.
According to Nasdaq, “When we think of growth stocks versus value stocks, there is a definition, which is more related to the underlying companies: value companies typically have low price-to-book values, high dividend yields, and low price-to-earnings ratios; growth companies have just the opposite. To put it more simplistically, value stocks will mostly consist of financials, healthcare, industrials, energy stocks. Growth stocks are mostly going to be tech-related: technology, discretionary (which houses Amazon and Tesla), and communication services.”
Several indices track growth and value stocks. Overall, the S&P 500 tracks the performance of 500 large companies listed on U.S. stock exchanges. The S&P 500 Growth Index tracks about 500 stocks in the S&P 500. According to S&P Dow Jones Indices, “The S&P 500® Pure Growth index is a style-concentrated index designed to track the performance of stocks that exhibit the strongest growth characteristics,” including sales growth, earnings change to price ratio, and momentum. The S&P 500 Value Index does the same for value stocks, measured by the ratios of book value, earnings, and sales to price.
Growth Investing vs. Value Investing: Which Is Better?
This battle—and question—has existed for years. These stock types are often pitted against each other—you can invest in growth stocks OR you can invest in value stocks. But there’s often room for both in your portfolio, especially as you lean into more diversification. Of course, diversification neither guarantees a profit nor ensures against a loss. If you listen to our podcast, Protect Your Assets, you’ll often hear David Hollander discuss growth and value stocks in relation to the current economic climate in his market segment. Catch the weekly market segments here.
Sometimes, certain stocks are included in both value and growth ETFs and mutual funds, further muddying the waters between the two. The difference comes down to the fact that these distinctions are not set in stone, can change and evolve, and have an element of influence from analysts and public opinions. Growth stocks can become value stocks over time and vice versa. No matter which investment strategy you abide by, investors’ goal is the same albeit done differently: buy low and sell high.
So, which category is better for your portfolio? Well, answering this depends on the economic climate and stock market conditions and is a personal question for each investor—your time horizon for investing, risk tolerance for price volatility, and overall financial goals, among other things, must be factored in when evaluating your overall portfolio composition. Theoretically, value stocks are considered lower risk because they represent larger companies that are more established. Growth stocks represent a riskier investment—because the companies are in growth mode, dividends are generally not paid out to investors; instead, they’re usually reinvested back into the company to further drive growth and expansion. As a caveat, dividends are not guaranteed and may fluctuate or stop altogether. Also, because investors are usually purchasing these stocks at a premium on the expectation that the company’s growth will continue (and quickly), the risk for loss of profitability is greater, especially if the company’s growth doesn’t meet expectations.
The stock market is cyclical in nature, which means certain conditions may favor growth stocks (e.g., when interest rates are rising) and other conditions may favor value stocks (e.g., when the economy is in recovery mode after a crisis). According to Investopedia, “It should be noted that over shorter periods, the performance of either growth or value will also depend in large part upon the point in the cycle that the market happens to be in. For example, value stocks tend to outperform during bear markets and economic recessions, while growth stocks tend to excel during bull markets or periods of economic expansion. This factor should, therefore, be taken into account by shorter-term investors or those seeking to time the markets.”
It’s also important to note that these investment strategies boil down to what industry the stocks are in. According to NerdWallet, “Currently, more than a third of stocks in the S&P 500 Pure Growth index are in the information technology sector, while about a third of stocks in the S&P 500 Pure Value index are in the financial sector. This breakdown makes sense: The country’s major financial institutions are far more established than the relatively new leaders in information technology.”
Growth stocks may be more appealing to you if:
- You don’t need income currently from your portfolio
- You have a greater risk appetite, meaning ups and downs in stock share prices don’t spook you too much
- You’re confident in your ability to pick the winning emerging growth stocks
- You have a longer time horizon before you need to use the money invested in growth stocks
Value stocks may be more appealing to you if:
- You need current income from your portfolio, as value stocks often pay dividends
- You have a lower risk appetite, meaning stock price volatility has a greater impact on your mindset and emotions around investing and your money
- You feel confident in your ability to pick the right value stocks and avoid value traps
- You have a more immediate need for your investment to pay off
You can, of course, go all in on one investing strategy—the either-or mentality. Another strategy is to invest in both stocks proportionally; this diversifies your portfolio and hedges against one when the other is in favor. Because of value-growth market cycles, it’s important to rebalance your portfolio at certain intervals, especially if your allocations shift out of whack by 5% or more. Finding the appropriate mix for your needs can be complex, so it’s advisable to seek out help from a financial professional if this goes beyond your current financial/investing skillset or if you want a second opinion from someone in the field.
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This blog expresses the author’s views as of the date indicated, are subject to change without notice, and may not be updated. The information contained within is believed to be from reliable sources. However, its accurateness, completeness, and the opinions based thereon by the author are not guaranteed – no responsibility is assumed for omissions or errors. This blog aims to expose you to ideas and financial vehicles that may help you work towards your financial goals. No promises or guarantees are made that you will accomplish such goals. Past performance is no guarantee of future results, and any expected returns or hypothetical projections may not reflect actual future performance or outcomes. All investments involve risk and may lose money. Nothing in this document should be construed as investment, tax, financial, accounting, or legal advice. Each prospective investor must evaluate and investigate any investments considered or any investment strategies or recommendations described herein (including the risks and merits thereof), seek professional advice for their particular circumstances, and inform themselves about the tax or other consequences of any investments or services considered. Investment advisory services are offered through Liberty Wealth Management, LLC (“LWM”), DBA Liberty Group, an SEC-registered investment adviser. For additional information on LWM or its investment professionals, please visit www.adviserinfo.sec.gov or contact us directly at 411 30th Street, 2nd Floor, Oakland, CA 94609, T: 510-658-1880, F: 510-658-1886, www.libertygroupllc.com. Registration with the U.S. Securities and Exchange Commission or any state securities authority does not imply a certain level of skill or training.
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Cussen, Mark. (August 29, 2021). Value or Growth Stocks: Which Is Better? Investopedia. https://www.investopedia.com/articles/professionals/072415/value-or-growth-stocks-which-best.asp#:~:text=Growth%20stocks%20are%20those%20companies,thus%20provide%20a%20superior%20return.
Hardin, Tom, & Bischof, Brandon. (May 6, 2021). Value vs Growth: A Brief Historical View. Nasdaq. https://www.nasdaq.com/articles/value-vs-growth%3A-a-brief-historical-view-2021-05-06
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Levy, Adam. (February 7, 2022). Value vs. Growth Investing: Which Should You Buy? Motley Fool. https://www.fool.com/investing/stock-market/types-of-stocks/growth-stocks/value-vs-growth-stocks/
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