Growth vs Value
Which is better?
In the very first edition which can be found here, I mentioned that my own investment portfolio allocation consists of roughly 60% growth stocks and 40% value stocks. Broadly speaking, every stock can be classified into one of two buckets: growth or value. In this edition, I will examine the differences between both and answer the age old question of which is better?
Growth stocks are companies that come with a significantly higher growth rate compared to the average growth rate in the market. This means that the stock grows at a faster rate than the average stock in the market, consequently generating earnings at a faster rate. Growth stocks have the potential to achieve high earnings growth but have not established a history of strong earnings growth. Growth stocks concentrate on growing their revenue often at the cost of delaying profitability.
Growth stocks are believed to have a good chance for considerable expansion over the next few years because they have a product or products that are expected to sell well or because they appear to be managed better than many of their competitors and as a result are predicted to gain an edge on them in their market.
Higher price than the market average - Investors are willing to pay high price-to-earnings multiples with the expectation of selling them at even higher prices as the companies continue to grow
High earnings growth records - While the earnings of some companies may be strained during periods of slower economic activity, growth companies may potentially continue to achieve high earnings growth regardless of the economic climate
More volatile - The risk in buying a growth stock is that its inflated price could fall sharply on any negative news about the company, particularly if earnings growth slows down
Little or no dividends - The company is instead reinvesting all their profits back into the company for future growth opportunities
Examples - Amazon, Google, Netflix, Tesla
A book that I would recommend on growth stocks specifically is One Up On Wall Street by Peter Lynch.
Value stocks are companies that are being traded at a value lower than their intrinsic value. This means that value stocks are being traded at a price lower than their true value and are therefore undervalued.
Value stocks are usually larger, more well-known companies that are trading below the price that analysts feel the stock is worth, depending on the financial metrics that it is being compared to. For example, the book value of a company’s stock may be €50 a share, based on the company’s capitalisation (Assets minus liabilities) divided by the number of shares. Therefore, if it is trading for €40 a share, this can be considered a good value play.
Lower priced than the market average - The principle behind value investing is that stocks of good companies will bounce back in time and the true value will be recognised by other investors
Priced below similar companies in industry - The majority of value stocks are created due to investors' overreacting to recent company news, such as disappointing earnings or negative publicity, raising questions about the company’s long-term prospects
Less volatile - As the stock is priced more conservatively, share prices are often less volatile than the market average
Pay dividends - The company doesn’t reinvest the entirety of their profits back into the company and instead returns it to shareholders in the form of a dividend
Examples - Coca-Cola, McDonalds, Procter & Gamble, Bank of America
Which is better?
It depends on your own personal goals. Both growth stocks and value stocks offer attractive investing opportunities. The best investment style for you depends largely on your financial goals and your investing preferences.
In the chart below, I have used the Vangaurd Growth EFT to represent the average returns of growth stocks and the Vanguard Value ETF to represent the average returns of value stocks. We can see that the Vanguard Growth ETF has outperformed the Vanguard Value ETF over the past 15 years since both were first introduced.
Growth stocks suit individuals who are:
Not interested in current income from your portfolio - Most growth stocks don’t pay dividends
Comfortable with big stock price swings - The price of a growth stock tends to be extremely sensitive. When things are going better than expected, growth stocks can soar in price. When they under deliver, higher-priced growth stocks can come crashing down
Confident that you can pick winners in emerging industries - Growth stocks operate in fast-moving areas of the economy, such as technology. It is common for many growth companies to be competing against each other
Value stocks suit individuals who are:
Desiring current income from your portfolio - Value stocks pay out substantial amounts of cash as dividends to their shareholders
Seeking more stable stock prices - Value stocks don't tend to experience large movements in either direction. As long as business conditions remain predictable the stock price volatility is usually low
Confident that you can avoid value traps - In many cases, stocks that look cheap are value traps, or cheap for a good reason. You will need to be able to look past attractive valuations to spot when a company's future business prospects are poor
As mentioned at the beginning, my portfolio allocation consists of roughly 60% growth stocks and 40% value stocks. I do not consider myself to be a growth investor or a value investor. I am a hybrid and adopt a blended approach. I believe that their are merits to both options. I invest in companies that I believe will be bigger and better in the years to come. Sometimes these might be growth stocks and sometimes these might be value stocks.
Owing to my own personal goals, time horizon and risk tolerance I am comfortable with big price swings on growth stocks and equally comfortable receiving dividends from value stocks which I can then reinvest in my portfolio. A combination of growth and value stocks also gives my portfolio that extra bit of diversification beyond the industry allocation. Choose a portfolio allocation that is relevant to your own goals and what you feel comfortable investing in.
In next weeks edition, I will be reviewing the monthly performance of my own portfolio for November 2020. I will be giving you an over-the-shoulder look at my portfolio including all of the transactions during the month and comparing how I stacked up versus the market. Hit the subscribe button below if you have not already done so in order to receive the latest content straight to your inbox each week. Please also consider sharing with a friend if you find the content useful.
If you can’t wait until next week, you can check out the guest post on Moving Averages that I was kindly invited to do for EngineerMyFreedom.com.
Wolf of Harcourt Street
Disclaimer: I am not a financial adviser and I am not here to give specific financial advice. The opinions expressed are for general informational purposes only and are not intended to provide specific advice or recommendations for any individual or on any specific security or investment product. The information is based on personal opinion and experience, it should not be considered professional financial investment advice. There is no substitute for doing your own due diligence and building your own conviction when it comes to investing.