Among the options you might consider are growth and value stocks shares. These two types of assets have fundamental differences in terms of price, expected performance and level of risk, but often you may want to have a combination of both in your portfolio.
Growth stocks versus value stocks
There are many differences between growth and value shares. Each of these asset types offers valuable advantages and disadvantages that are worth considering carefully. And depending on your specific goals, both can play a valuable role in your overall investment strategy.
Growth stocks: A growth stock is one that is expected to increase in value and beat the market, earning above average returns over the long term. Growth stocks typically come from companies or industries that are expected to expand. Because these stocks are expected to perform so well, you may pay a premium for them.
“Growth stocks are those with great potential to outperform, mainly because of the outlook for stronger earnings growth,” said Kevin Gordon, senior investment strategist at Charles Schwab. “They are often considered ‘great’ given their significant outperformance from time to time, such as during the technology boom of the late 1990s. But with that comes increased risk when a downturn approaches.”
Value of shares: On the other hand, value stocks are stocks of companies that are considered undervalued for one reason or another. As such, these stocks trade at a discount to the company’s assets.
“Value stocks trade below their intrinsic value and are often seen as hidden gems in the market,” says Gordon. “Many (not all) value stocks tend to be tied to the economic cycle, meaning they tend to perform well when a recession ends and a new cycle begins, and vice versa.”
What is growth stock and how does it work?
A growth stock is a company’s stock that is expected to grow at a rate higher than the average market growth rate. Companies that fall into this category generally prioritize rapid growth, whether it’s increasing revenue, developing new products, expanding market share, or moving into new areas.
Another feature of growth stocks is that they tend to be expensive. Their share price is usually high compared to current earnings. These stocks are also riskier by some measures because there is no guarantee of future success.
Pros and cons of rising stocks
There are many benefits associated with inventory growth investmentsbut these assets are not without risk.
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- Can beat the market: Growth stocks are expected to grow at a rate higher than the market average.
- Capital gains: These shares are expected to increase in value over time, which the owner could cash in on by selling the shares after they rise in price.
Against
- Expensive: Growth stocks tend to be priced high, especially relative to their current earnings.
- Greater risk: These stocks can be volatile and can crash, which can be a costly failure given that they are usually expensive assets to buy.
- No short-term returns: Getting paid with growth stocks requires patience as they take time to grow in value.
What are value stocks and how do they work?
A value stock is any share of a company that is trading at a level that is believed to be lower than its intrinsic value, and therefore value can be found.
“Value-driven businesses tend to be older, established businesses with a proven track record of success,” says Gardner. “Value stocks can be categorized by high levels of profitability and consistent, albeit lower, growth.”
Some examples of value stocks include Target, Exxon, and Bank of America, all large companies with decades of proven success.
Another important point about value stocks is that compared to growth stocks, these companies tend to prioritize free cash flow and returning profits to investors, ensuring income in the form of dividends or stock buybacks instead of aggressively reinvesting that money back into the business.
“Value investors can expect to benefit from profits (income) and moderate levels of share price appreciation as the market appreciates these profit streams more over time (growth),” explains Gardner.
Pros and cons of value stocks
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- Enable income: Unlike growth stocks, value stocks can provide short-term income in the form of dividends.
- Underrated: These stocks are usually undervalued or relatively cheap compared to the perceived value of the company.
- Less unstable: Value stocks tend to be more established companies that have a history of providing protection bear market.
Against
- Take longer to appreciate: Value stocks can take several years to rise in price, so patience is required.
- Potential dead end: There is no guarantee that the stock will ever increase in value.
- Recognition challenge: Finding a true value stock, one that is currently undervalued and could rise in value when the market corrects, requires a savvy investor.
How to choose between the two
Accumulating portfolio assets is a very personal decision for each investor, one that should be based on short-term goals, long-term goals, risk tolerance, and any other financial needs you may have.
Growth stocks tend to be more volatile, more expensive and take time to reach their full potential. As such, they are best used in pursuit of long-term financial goals. On the other hand, value stocks tend to be more consistent in terms of earnings, are less risky or volatile, and are often a good choice for generating higher short-term income.
However, when considering value and growth stocks, you don’t necessarily have to choose one to the exclusion of the other. In fact, some experts suggest that a well-diversified investment portfolio will include a balance between both.
“The winning portfolio includes both a long-term allocation to outstanding growth companies and an allocation to less volatile, more consistent value-focused companies,” says Joe Percoco, co-founder and co-CEO of Titan.
