What’s The Difference Between Growth & Value Investing?
Growth and value refer to two categories of stocks and the investing styles built on their differences. Investors looking for stocks that will deliver better-than-average returns often find themselves dabbling with growth stocks. Meanwhile, value stocks typically refer to companies that are currently trading below their intrinsic value and could provide superior return.
Both growth and value stocks can bring returns to investors. The difference lies mainly in the way in which they are perceived by the market and, ultimately, the investors. And understanding the idea of growth stocks and value stocks can help your portfolio work better for you. But before that, it’s crucial to understand what could move the stock market in 2022.
What’s Happening In The Stock Market Right Now?
Before we compare these two groups of stocks, it may help to take a step back and think about how to maneuver in the highly volatile stock market. There are plenty of arguments that the bull market could continue for the U.S. stock market this year. However, investors’ focus appears to have shifted recently in favor of value stocks, rather than the growth stocks that helped drive major indexes to new highs.
In the past year, there have been a few occasions where there has been a rotation to value, only to see the stock market revert its focus to growth stocks again. But that could very well change in 2022. For one, the Federal Reserve is planning to stop its massive net purchase of the U.S. Treasury bonds and mortgage-backed securities in March.
Minutes from the Fed’s December meeting had shown that a tight jobs market and persistent inflation could require the U.S. central bank to raise rates sooner than expected. And in a rising-rate environment, it would undoubtedly put pressure on some of the highest-flying growth stocks. Considering all this, how you allocate your funds across growth stocks and value stocks could be the defining factor in shaping your portfolio performance this year.
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Growth Stocks: Higher Risk With Potentially Higher Rewards
Growth stocks are considered by experts to have the potential to outperform the overall markets. For starters, growth names tend to be found in newer and smaller-cap companies, and in growth sectors like technology. As the name suggests, growth is the priority. Oftentimes, these companies would tend to concentrate on building up their revenue at the cost of delaying profitability. You would see these companies reinvest their earnings in themselves in order to expand. Be it in the form of expansion of workers, equipment or acquisitions. Examples of growth stocks include Amazon (NASDAQ: AMZN), Alphabet (NASDAQ: GOOGL) and Meta Platforms (NASDAQ: FB).
Generally, they tend to have high price-to-earnings (P/E) and high price-to-sales (P/S) ratios. In other words, they are usually more “expensive”. This is due to expectations from investors of high sales or profits in the future. Either because they have a product or line of products that are expected to sell well and have a good chance for considerable expansion. As such, risk-tolerant investors may be willing to pay a premium to own these shares.
Proponents of growth stocks have no trouble with those high P/E ratios because they believe they are investing in the future. Nevertheless, although investing in growth stocks can reap some of the greatest rewards, it also poses some of the highest risks. Now, there’s no question that growth stocks have been under severe pressure in recent months. And speculating for a rebound anytime soon could be extremely risky for some. But if you could take the risks, some of the hypergrowth names are trading at a more reasonable valuation now. Thus, initiating a position in some of the top growth stocks today could provide a better risk-reward profile than a few months back.
Value Stocks: Well Worth The Price
Value stocks are those with relatively cheap valuations relative to their earnings and long-term growth potential. And they tend to be companies with more mature businesses. Of course, valuation is somewhat in the eyes of the beholder, but some top value stocks in the stock market would include Intel (NASDAQ: INTC), General Motors (NYSE: GM) and International Business Machines (NYSE: IBM).
Since many of these are older businesses whose exciting days are behind them, it’s easier for the market to underestimate their growth potential. That’s especially the case when they have big plans to venture into a new business. And they certainly have the financial capabilities to do so with their own balance sheet. One prime example here would be General Motors. The legendary automaker announced that it will increase its electric vehicle and automotive vehicle investments to $35 billion through 2025.
Don’t get me wrong though, when we say a stock is “cheap”, we are not referring to the nominal price of a stock. For example, a $100 stock can be cheap and a $20 stock can be expensive. Rather, it reflects whether the stock is worth that price using one or more valuation multiples. Unlike growth stocks, value stocks tend to return more cash to its shareholders in the form of dividends. Considering that the stock market has been moving sideways since the start of the year, it makes even more sense to put up a list of top value stocks to buy.
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Growth Stocks Vs Value Stocks: Which Is Better?
Both growth stocks and value stocks offer lucrative investing opportunities for their shareholders. There’s no clear-cut winner between these two. When the broader economy is in good shape, growth stocks on average tend to be the better performer. And during trying times like now, value stocks tend to hold up better. So, which is better depends a lot on when you’re initiating a position.
You’re more likely to be investing in growth stocks if you’re not interested in recurring income from your portfolio. After all, most growth stocks do not pay dividends. Younger investors with longer time horizons may want to skew their portfolios in favor of growth. Perhaps, most important of all, you have to be able to stomach big price swings in either direction.
On the flip side, value stocks may be appealing to you if you seek dividend income or stability in stock prices. Yes, they may be stodgier, but they are usually steadier. Even though they don’t rise as much as the broader index, we can’t deny that they hold up better when everything is selling off. All in all, having a diversified exposure to both in your portfolio might just give you the best of both worlds.
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