Investing is the best way to save for retirement or pay for your child’s education, but it requires careful thinking and strategizing if you want to earn the returns you need. While there are many approaches to consider, one of the most important decisions you will make is choosing value vs. growth investing. Each has its benefits and risks.
At Addition Financial, we always want our valued members to have the information they need to make their financial goals into realities. That includes understanding investment strategies and what they mean for our membership's future. With that in mind, here’s our guide to the value vs. growth investment styles, with definitions and examples of each.
Growth stocks are stocks that are expected to grow at a rate that outstrips the market, delivering higher-than-average total returns to investors. In many cases, growth stocks are small-cap stocks, which means they have market capitalization between $300,000 and $2 billion. They may be companies that have just begun trading publicly or alternatively, small companies that have been around for a while but have exhibited significant growth potential.
There are some characteristics that growth stocks have in common with one another. If you’re considering a growth investment strategy, then look for these things:
It’s important to keep in mind that another characteristic of growth stock is that investing in it carries some risk above and beyond what you would see with other types of investments.
Growth investments may come in several forms. Here are some of the most common types of growth investments:
If you do decide to try a growth investment strategy, we recommend avoiding speculative investments and balancing your portfolio with some lower risk investments to protect yourself.
A value stock is a stock that may be undervalued in the market, meaning that it is trading at a price that investors feel is too low based on the company’s historic performance and earnings. As a rule, value stocks tend to be from companies that are large and well-established. They often pay dividends and are more likely to do so than smaller companies.
Here are some of the characteristics to look for when evaluating stocks to see if they are value investments:
As you can see, the key is using a variety of metrics to give you an idea of how much value you can expect to see from your investment.
The P/E ratio is one of the easiest ways to identify value investments. Here are two examples as of April 2023:
The benefit of investing in value stocks is that you are likely to earn a return on your investment as the stock you buy increases to its book value.
Now, let’s look at a few of the most important differences between growth investing and value investing.
The first and arguably the most important difference between growth investing and value investing is the risk involved. Value stocks tend to be from large, well-established companies that are outperforming their market value. While there is still some risk involved in buying value stocks, it is small compared to the risk in growth investments.
Growth investments are based on a company’s future potential and not on its history. These companies may experience exponential growth, but there is also a high risk of failure. Even if you do extensive research, there’s still a risk that you may lose some (or all) of your investment.
Both value stock and growth stock have the potential to earn money for investors. The difference is that value stocks provide the opportunity for slow and steady growth. Because they are typically undervalued in the market, there’s a strong likelihood that your investment will gain value as the market price catches up to the book value.
By contrast, growth investments have the potential to experience tremendous growth, particularly if the company in question launches a new product that disrupts the stock market and changes things for the better. On the flip side, there’s also the possibility that you’ll earn less with a growth investment if the company underperforms and never realizes its potential.
If you’re interested in turning your investments into monthly income, your best option is to choose dividend stocks. Most companies that pay dividends do so on a quarterly basis and the income can offset the cost of buying the stock, but it may also lead to slower overall growth.
As we noted above, value stocks are more likely to pay dividends than growth stocks, although growth stocks sometimes do. You can use the dividend discount method we described above to evaluate the earning potential of a dividend stock.
Here are some things to consider before you choose an investment strategy:
If you’re unsure about which investment strategy will deliver the results you want, you may want to work with a financial professional to discuss your options.
Both value investments and growth investments have their benefits, and the best investment strategy is to balance the two to deliver a combination of stability and potential earnings. You can see the metrics and methods we’ve discussed here to evaluate your investments before you buy.
Do you need assistance evaluating potential investments and building your portfolio? Addition Financial is here to help! Click here to learn about our Financial Services and schedule an appointment with a financial professional today.