Though growth stocks typically garner the spotlight, value strategies can still play a vital role in any portfolio. Diversifying and diversifying can increase long-term returns significantly. Both styles offer their own set of advantages and disadvantages; which style best fits you depends on your risk tolerance, investment goals, and time horizon. But how can you choose between growth and value investing?
1. Stock Valuation
Stock valuation is the practice of estimating what a company’s worth is. Understanding this practice allows investors to identify undervalued and overvalued companies, establish potential profit from purchasing particular stocks, and gain greater insight into industry trends.
As an example, if earnings are expected to grow rapidly but are currently trading at a relatively high price-to-earnings ratio (P/E), then this company may be considered undervalued. Conversely, when its stock is trading below its historical average P/E ratio, it could be undervalued.
2. Dividend Policy
Companies focused on growth tend to experience greater fluctuations in earnings and dividends compared to companies with a balanced approach to dividend policy, so it is critical when assessing investment potential that one take note of their dividend policy.
Growth stocks often pay no or few dividends, reinvesting their proceeds back into their business to speed its expansion. They are therefore considered higher risk and may become less desirable during market downturns and corrections. Over the past decade or more, growth has outshone value. Yet history shows that leadership between these styles may shift at any time—value offers a compelling long-term performance record.
3. Cash Flow
Cash flow is an indispensable metric that enables you to assess a company’s financial health and make important business decisions. For instance, it enables you to determine whether a profitable firm meets long-term growth expectations.
Evaluating your personal finances is also an invaluable exercise. Start by calculating your net monthly income—comprising both salary and any steady sources like dividend or interest payments—which will give you a sense of where your finances stand as you prepare to invest.
4. Growth Potential
Growth stocks offer the possibility for extraordinary returns during periods of rapid expansion, but their stock prices can quickly decrease after experiencing setbacks. Therefore, growth investments should form part of a diverse portfolio that also includes other investment styles.
Value and growth investing have historically followed cyclical patterns of performance. When one style outperforms another, investors may become overconfident in that strategy and may overly commit their money. Value investors look for companies trading at prices that reflect a discount to their intrinsic worth, anticipating that, over time, the market will recognize this value and cause its stock price to increase accordingly.
5. Risk
Investment in growth stocks comes with its own share of risk. They tend to be more costly than their broader market counterparts and could inevitably disappoint if expectations don’t pan out as anticipated. Therefore, many investors prefer “blended” funds, which aim to capture growth premiums while simultaneously monitoring value indicators.
Investors should carefully consider their own risk tolerance and investment goals when choosing between growth and value investing strategies. Both styles have proven their worth over time based on economic cycles; diversifying one’s portfolio is therefore vitally important.
6. Price Trends
Value investors pursue stocks selling at discounted prices due to management changes or quality concerns, anticipating earnings growth that will eventually justify their purchase price. Growth stocks tend to outshine value stocks during prosperous economic conditions; however, growth stocks may outshine value stocks when conditions turn harder. Your decision whether or not to include growth stocks in your portfolio should ultimately depend on your personal risk tolerance and investment goals.
Pfizer’s Covid vaccine announcement may serve as a catalyst for value outperformance, while tightening monetary policy and rising inflation could serve to decrease interest rate-driven headwinds that have buffeted growth strategies in recent years.
7. Time Frame
Exhibit 4 shows how Value has consistently outperformed Growth over time. There are various indicators suggesting this trend will persist, including tightening monetary policy, signs of an economic upturn (manufacturing PMI inflected above 50 in March 2024), extreme positioning with wide valuation spreads, and strong earnings trends for value sectors.
Understanding the differences between growth and value investing is vital in creating an investment strategy tailored to your financial goals, risk tolerance, and trading style. Get started investing with J.P. Morgan Self-Directed Investing now for up to $700 cash bonus.
8. Expectations
Growth stocks offer investors high returns but also carry greater risk than other forms of investments. To manage this risk, investors may wish to utilize dollar-cost averaging or diversify across companies and sectors. Growth stock valuations often surpass earnings expectations, leading to rising expectations that can be hard for companies like Apple or Nvidia to meet. Even successful growth companies face this difficulty when meeting them.
Financial experts question the longevity of Growth’s recent outperformance; history teaches them otherwise, and Value will likely regain its position over time.
9. Conclusions
While Wall Street often classifies stocks into categories of growth or value investing, many companies possess elements of both. Investors with higher risk tolerances may find growth investing rewarding.
Growth investors prioritize future potential, willing to pay a premium for shares that appear expensive based on valuation metrics. They anticipate earnings will expand quickly enough in the future to justify this higher price tag and achieve strong long-term returns for investors. Although growth investments typically provide strong long-term returns, growth doesn’t come without risks; style leadership frequently shifts between value and growth investments, so it is wise to be prepared for possible shifts between the two styles.