What is the difference between growth and value investing?
Growth and value refer to two classes of stocks and investment styles based on the differences between them. Investors looking for stocks that will yield better-than-average returns often find themselves immersed in growing stocks. Meanwhile, stock value usually refers to companies that are currently trading at less than their intrinsic value and can provide a higher return.
Both growth and value stocks can bring in returns for investors. The difference mainly lies in the way the market and, ultimately, the investors are perceived. And understanding the idea of growth stocks and value stocks can help your portfolio work better for you. But before that, it is important to understand what could move the stock market in 2022.
What is happening in the stock market now?
Before we compare these two groups of stocks, it can be useful to take a step back and think about how they can maneuver the highly volatile stock market. There are plenty of arguments that the bull market may continue in the US stock market this year. However, it appears that investors’ focus has recently shifted in favor of value stocks, rather than the growing stocks that have helped propel major indexes to new highs.
In the past year, there have been several occasions where there has been a rotation of value, only to see the stock market refocus its attention to growing stocks again. But that could very well change in 2022. On the one hand, the Fed plans to halt its massive net purchases of US Treasuries and mortgage-backed securities in March.
The minutes of the Federal Reserve’s December meeting showed that a tight job market and persistent inflation may require the US central bank to raise interest rates sooner than expected. In an environment of high growth rate, this is sure to put pressure on some of the top-flying growth stocks. Given all of this, how you allocate your money across growth stocks and value stocks could be the determining factor in shaping your portfolio’s performance this year.
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Growth Stocks: Higher Risks With Higher Returns
Experts consider growth stocks to have the potential to outperform the markets as a whole. For starters, growth names tend to be found in new and small businesses, and in growth sectors like technology. As the name suggests, growth is the priority. Often, these companies tend to focus on increasing their revenue at the expense of delaying profitability. You will see these companies reinvest their profits back into themselves in order to expand. Whether that’s in the form of expansion of workers, equipment, or acquisitions. Examples of growth stocks include Amazon (NASDAQ: AMZN), the alphabet (NASDAQ: GOOGL) and ID pads (NASDAQ: FB).
In general, they tend to have a high price-to-earnings (P/E) and high price-to-sales (P/S) ratio. In other words, they are usually more “expensive”. This is due to investors’ expectations of higher sales or profits in the future. Either because they have a product or a line of products that are expected to sell well and have a good chance of expanding significantly. As such, risk-taking investors may be willing to pay a premium to own these shares.
Proponents of growth stocks have no problem with such high P/E ratios because they believe they are investing in the future. However, although investing in growing stocks can reap some of the biggest rewards, it also poses some of the highest risks. Now, there is no doubt that growth stocks have been under severe pressure in recent months. Predicting a rebound anytime soon may be too risky for some. But if you can take the risk, some over-growth names are trading at a more reasonable valuation now. Thus, starting a position in some of the high-growth stocks today can provide a better risk-reward profile than it did a few months ago.
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Stock value: worth the price
Value stocks are those with valuations that are relatively cheap relative to their earnings and long-term growth potential. They tend to be companies with more mature businesses. Of course, the valuation is somewhat in the eyes of the beholder, but some of the most valuable stocks in the stock market may include Intel Corporation (NASDAQ:INTC), general motors (NYSE: GM) and International Business Machines (NYSE: IBM).
With many of these companies being older companies and having their exciting days, it is easy for the market to underestimate their growth potential. This is especially the case when they have big plans to venture into a new business. And they certainly have the financial capabilities to do so through their balance sheet. One of the main examples would be here general motors. The legendary automaker has announced that it will increase its investment in electric vehicles and cars to $35 billion through 2025.
Don’t get me wrong, when we say a stock is “cheap,” we are not referring to the nominal price of the stock. For example, a $100 stock can be cheap and a $20 stock can be expensive. Instead, it reflects whether the stock is worth that price by using one or more valuation multiples. Unlike growing stocks, value stocks tend to return more liquidity to their shareholders in the form of dividends. Given that the stock market has been moving sideways since the beginning of the year, it makes more sense to list the stocks with the highest value to buy.
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Growth Stocks vs. Value Stocks: Which is Better?
Both growth stocks and value stocks provide profitable investment opportunities for their shareholders. There is no clear winner between these two. When the broader economy is doing well, growth stocks tend on average to be the best performers. And during tough times like now, value stocks tend to hold out better. So, which one is better depends a lot on when the position starts.
You are more likely to invest in growing stocks if you are not interested in recurring income from your portfolio. After all, most growth stocks don’t pay dividends. Younger investors with longer time horizons may want to skew their portfolios in favor of growth. Perhaps, most important of all, to be able to withstand large price fluctuations in either direction.
On the flip side, value stocks may be attractive to you if you are seeking dividend income or stock price stability. Yes, they may be sturdier, but they are usually more stable. Although it doesn’t go up as much as the broader index, we can’t deny that it holds up better when everything is sold out. Overall, a diverse exposure to both in your portfolio may give you the best of both worlds.
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