Growth and value investing are two contrasting investment strategies that have been the topic of a fiery debate for decades. Today, we’re pitting growth stocks vs value stocks to see which one comes out on top. Read on for the full breakdown.
What Are Growth Stocks?
Growth stocks belong to companies that generate better earnings than the market average. They are also expected to continue outperforming the market in the future as well.
These stocks might have high market valuations, but given their trajectory of growth, those valuations can potentially climb even higher if the company continues to do well.
Such securities can be volatile since high investor expectations are built into their price.
If the company performs even slightly worse than expected, or there is adverse news about it or its industry, its stock price might take a tumble.
Related: What Is A Growth Stock?
Do Growth Stocks Do Well in a Recession?
Growth stocks tend to fare poorly during recessions. Typically, the prices of these stocks are heavily dependent on the expectations of growth investors about their future potential earnings.
During a global financial crisis, those expectations get tapered, which brings down the price of the stock.
Moreover, investors start to prefer value stocks that show steady and stable cash flows even during a recession.
Such stocks often belong to industries whose products and services will be needed during both good times and bad.
Some examples include energy, healthcare, FMCG, commodities, and so on.
Do Growth Stocks Pay Dividends?
As mentioned, growth stocks usually do not pay dividends. That’s fine, though, as investors are not interested in regular dividends from these stocks, anyway.
The philosophy behind this investing style is to gain capital appreciation as the price of the stock rises along with the earnings of the company.
If the firm is expecting huge growth in the future, it makes sense for it to reinvest all of its profits into R&D, better product design, marketing, etc.
Investing in these areas will help enhance future earnings. This, in turn, will help grow stock prices, creating a virtuous cycle that will be beneficial for a growth investor.
Paying out dividends will divert money from such activities and lower potential earnings.
Related: The 10 Best Monthly Dividend Stocks For Income Investors
Are US Growth Stocks Overvalued?
Growth stocks are usually overvalued. The high value of these stocks is based on the expectation of high growth in future earnings.
Investors are willing to buy growth stocks even at high valuations because they believe that the current price does not capture their full potential.
How much a firm can grow is hard to account for in conventional valuation metrics like price-earnings and price-book value ratios.
Often, expectations might be based on intangible factors, such as the sudden growth of an emerging technology or huge potential for market share gain due to a strong business model.
Judging the right price of a growth stock is often more of an art rather than a science.
Being tech-savvy doesn’t hurt, however, as many of the biggest growth stocks of the last decade were in tech.
What Are Value Stocks?
Value stocks are securities trading below what their “right” market value should be. Typically, these stocks have low price-to-earnings and price-to-book ratios compared to peers.
Value investors buy such stocks because they see them as a bargain. These are usually companies with steady, long-term cash flows that are trading below their ideal price.
They derive the ideal price of the stock using various metrics such as earnings ratios, debt to equity, cash flow statements, and so on.
Related: The 5 Best Cyclical Value Stocks To Buy Now
Do Value Stocks Do Well in a Recession?
Value stocks generally do well in a recession. These are companies with steady cash flows and long-term visibility of earnings potential.
Traders prefer such stocks when the markets are down because the underlying companies tend to do well during these scenarios.
Most value stocks come from sectors like energy and commodities, which continue to generate healthy cash flows even during a recession.
Something that is important to consider, though, is that value stocks are not impervious to downturns. Their value can drop if the market declines.
But strong fundamentals and stable business models could cushion the blow or help them recover sooner.
Do Value Stocks Pay Dividends?
Yes, value stocks often pay dividends. These are companies that have steady businesses with strong cash flows.
They do not need to reinvest a lot of money to achieve growth. Therefore, they prefer to reward investors with dividends from the earnings that they generate.
Are US Value Stocks Overvalued?
Value stocks are usually undervalued.
Currently, the Morningstar US Large Value Index has a price/fair value ratio of 1:1, which means that value stocks are still priced fairly.
Growth Stocks vs Value Stocks
Growth stocks are often more volatile and provide lower long-term returns but are perceived to be safer investments.
Value investing involves risk because the market perceives these securities poorly. Long-term results show, however, that value stocks offer better returns than growth.
In the following sections, we compare these two types of investment strategies in detail.
Are Growth Stocks Safer Than Value Stocks?
Value stocks are perceived as riskier than growth stocks. The reason is that, by definition, the market has a negative perception of them, which is why they were underpriced in the first place.
For the stock price to grow, the market would have to shed its pessimism.
Traders put a lot more faith in growth stocks since they are currently showing great returns and appear to have a high potential in the future as well.
A continued good run of earnings is all it takes for these securities to remain a darling in the eyes of stock market investors.
Do Value Stocks Outperform Growth Stocks in the Long Run?
Based on past performance, value stocks have outperformed their growth counterparts, but the last decade has seen a reversal of fortunes.
If we look at the performance of the two types of stocks from 1926 onwards, value investing has returned 1,344,600%, whereas growth investing returned only 626,600%.
However, in the previous decade, the Russell 1000 Growth Index returned 17% as compared to the 10% returns of the Russell 1000 Value Index.
Trends have shifted in the last two years, with value back on top. This is due to value stocks staying strong during economic turmoil.
The data, therefore, suggest that which type of investing style is outperforming often depends on current market conditions.
In any case, it might be a good idea to keep a diversified portfolio of growth and value stocks at any time to maximize returns.
Which Have Higher Volatility: Growth or Value Stocks?
Growth stocks have higher volatility. They carry more risk of crashing when a market scenario changes or something goes wrong with the company.
Much of growth stocks’ pricing is determined by the perception of the company having significant earnings growth potential.
A bad quarter with poor earnings or even a rumor in the market that shows the company in a negative light is enough to tarnish that perception.
Value stocks, on the other hand, are less volatile, and their prices are not purely perception driven.
These stocks’ prices usually reflect their strong cash flows and solid business plans that guarantee continued regular incomes.
Therefore, it is unlikely for value stocks to fall by as high a percentage as growth stocks might.
Should I Buy Growth or Value Stocks Now?
In the current economic and inflationary environment, it might be a good time to buy value stocks.
However, investors should not miss out on opportunities in the growth segment either, as long as these companies are fundamentally sound and have good long-term potential.
A mixed portfolio of both investing styles with a healthy concentration of value could be the best policy.
Final Thoughts
Growth and value investing are both sound strategies.
While growth stocks are considered less risky, they have lower long-term returns and are highly volatile.
On the other hand, value investing needs a contrarian mindset because these stocks are perceived poorly by the market, which is why they are underpriced.
That said, value investing has yielded better long-term returns over the last century, on average.
In a recession or when inflation is growing, value investing might be a better strategy because these stocks are usually backed by proven, profitable companies with strong business models.
However, when the economy is doing better, it may be wiser to opt for growth stocks.
Lastly, there is no rule that stops investors from choosing both — a prudent investor can select stocks from either investment styles as per their risk-taking ability and maximize returns.
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