What kind of stock picker are you? Do you prefer new, up-and-coming companies that grow quickly or mature stable companies with slow but steady growth? In this article, we explain growth versus value stocks, and how both can help you reach your investing goals.
When I invest, I prefer value stocks that provide slow growth but good income through dividends. My bestie, however, prefers to try to strike it rich with growth stocks that get all the media attention. But is one better than the other? Are either of us ever going to be billionaires? Read on to find out.
(Let’s hope at least one of us gets it right so the other can stop working, too.)
The Hare (Growth Stocks)
Analysts usually categorize stocks as growth stocks if they feel that the company will experience a period of expansion over the next few years and will likely outperform the market or a large part of the market. These companies are often new companies expected to make a big impact by creating a new market or an innovative product.
You can usually tell they are a growth stock because the media can’t stop talking about them. An example of a growth company is Google (GOOGL). Its earnings have grown much faster than the overall market, and as a result, its price has risen dramatically since its Initial Public Offering (IPO).
The big draw of growth stocks is their potential for large growth. They are considered more rewarding as they are riskier.
These stocks tend to be more expensive. That is, their prices are high compared to their sales or profits. People are willing to pay more for the potential for large growth. They also tend to be riskier. If expectations of high growth don’t materialize, the prices could plummet. (Read: the hare just fell off a cliff). Lastly, these companies generally do not pay dividends during their growth periods. They are too busy reinvesting all of their extra funds back into the company.
The Tortoise (Value Stocks)
Stocks are usually classified as value stocks if their prices are lower relative to earnings or dividends. These companies are usually mature with little or no growth and have a stable dividend payout. An example of a value stock is Louisiana-Pacific Corp (LPX). It has a relatively low price-to-earnings ratio (P/E ratio), which is indicative of value stock. It has also started paying a small dividend.
These stocks tend to be less expensive. In other words, their stock prices are relatively low compared to their projected earnings or profits. They also tend to be less risky. The companies have already proven themselves to be income generators. As a result, many value stocks also pay dividends. Slow and steady wins the race, am I right, tortoises?
Value stock companies tend to be buy-and-hold companies. They generally do not provide quick profits but rather grow slowly or not at all. As a result, huge surprise profits are virtually non-existent when it comes to these mature companies.
Which one is better?
You’re probably wondering, so how do I choose which type of stock to hold? Is one better than the other? Over the years, there have been arguments for both sides. Several studies have shown slow and steady value stocks to outperform growth stocks in the long run by about 1 percent. (The tortoise wins!) While value stocks have been shown to do well overall, especially in a recovering economy, they lag when the market is bullish (a bull market is a hot growing market). History has also shown growth stocks do well in a bull market but are the first to be punished if the market is cooling. Most of the choice is up to your personal style and how much risk you are willing to withstand. So get out there, do your research, and grab the “bull” by the horns!
P.S. still unsure and need to learn the basics of investing, check out this article to start!