Investing Styles: Growth Versus Value
When you are building a successful investment portfolio of stocks, there are various ways of achieving your goals. One way is to have an investment style. Two of the most popular investment styles are growth investing and value investing.
We will break down what each of these styles means. We will consider how they can impact past performance of your investments and how they can affect your returns. Ultimately though, when it comes to investing across a portfolio, should you just be using one investment style, or the other? Let’s take a look.
What Is a Growth Stock?
We will start with growth stocks. A growth stock is a company that is dedicated to fast growth. This could be the fast growth of revenue or the earnings growth, profits or even just market share.
Growth companies are often fairly young companies, maybe they are new to public markets. But moreover, they are companies packed with the ambition to grow. The ethos of growth investing is that growth companies will tend to pump any profits generated by the the company’s stock, back into the business to fast-track its growth.
When it comes to equity markets, a growth stock is usually all about the share price. Hopefully, if the company is any good, the shares will be rising relatively fast.
The shares will often be volatile and will tend to come with a beta of more than 1.0 (this means that they are more volatile than average shares in the broader market.).
However, another key feature is that many growth stocks pay little or no dividends to shareholders. As we mentioned earlier, the vast majority (often all) of the profits are used to fund investment for further growth. This means that if you are looking for a slow and steady income from dividends, then growth stocks are not for you. Tech stocks and web-based companies would be growth stocks. In short, you invest in future results.
A classic example of this would be the US online retailer and tech giant, Amazon. In the early 2000s, Amazon was all about revenue, building market share and reinvesting in the business.
The shares took off like a rocket after 2009 rallying from C. $3.50 to over $180 in 2021. That was over a decade of substantial return (until the shares fell by about 50% in 2022). However, to this date, Amazon has never paid a dividend. For Amazon, it’s been all about growth.
What is a Value stock?
Value stocks are seen as high-quality companies that have often been sold off and maybe unloved. However, the key is in the name.
The stocks are seen by many investors as being good value for which investors expect a longer-term return. Investors see that over the long run, the stock market will see the quality of the company and the shares will recover.
Value stocks are entirely different to growth stocks. There are two aspects to value investing:
- Buying strong companies that come with a cheap valuation
- Taking advantage of a high dividend yield for added income return.
Value Investing – Cheap Valuation
The key to value stocks is that the company comes with a relatively cheap valuation. Perhaps the stock attractive shares have sold off alongside less impressive peers. The valuation (or stock price) of such stocks is historically cheap compared to where value investors might expect they have traded historically.
Measuring how cheap investors priced value companies as in a reasonable price of the shares are is key to value traps. The share might trade at a discount on a price/earnings ratio basis, or a discount to its Net Asset Value. in Value traps, investors will look to buy companies that are trading below their intrinsic value.
Value Investing – Dividend Yield
The other key aspect is the dividend yield. One big advantage that many value sectors and many stocks tend to have is the dividend yield. Even if the shares might not be performing very well in the near to medium term, many traditional value sectors and many value stocks, can still be paying out a dividend yield of perhaps 4%, 5% or maybe even higher. This ensures that investors get a return on their investment even if there is no immediate capital appreciation.
Value stocks will also be typically seen as being towards the safer end of the spectrum of equity investments. Value stocks are likely to be lower risk and therefore should trade with lower volatility. They would tend to come with a beta of less than 1.0 (less volatile than the market average).
The most famous value investor of them all is Warren Buffett. We could write reams and reams about Buffett’s investing style. However, his broad mantra is to buy strong companies (ideally with a cheap valuation) that hold a competitive advantage in their sector.
He will then hold them for years (even decades). Buffett is the classic buy-and-hold investor that typifies value investing. Former Microsoft CEO Bill Gates once laid out what he learned from Warren Buffet in The Harvard Business Review.
Growth Versus Value Investing
Growth stocks might seem expensive from the outset to many investors. However, the fast expansion of the business and the prospect of huge future growth investor profits delivered earnings growth will mean that markets will often place above-average or even high valuations on growth stocks. This does not mean that they will not have the capability to move even higher. It is the nature of the beast with a growth investing strategy.
Growth stocks will tend to have a relatively high P/E ratio (maybe high-teens or above 20) or a high Price/Sales ratio, reflecting an expensive valuation. However, growth companies might be able to justify higher price than this with the expansion of the business that is in the pipeline.
Growth investors buy for what they see as the future of the value vs future profit potential growth of the company. However, therein lies the risk. What if growth is not possible? Maybe the market has overestimated its value vs growth and capacity for growth.
Value stocks are investments in well-established companies and are seen as safer investments. Investors look at stable stock prices for a company with a solid track record of business performance, cash flows and dividend payments. If the stock price is undervalued it is an opportunity to buy a strong company at a cheap valuation.
However, there is still a risk in picking up companies with a cheap valuation and a high dividend yield. There might be a good reason for a low stock price. The risk is that the company may not be that good, or is in an industry that is in terminal decline. It might have been sold down to a cheap valuation for a good reason. This is known as a “value trap”.
Also, companies that have a high dividend yields or yield that is higher than the p/e valuation need to be treated with caution. Is the market telling us something? Could a dividend cut be on the way?
There are questions that a value investor needs to be considering. It is always advisable for value investors and value indexes to have a comprehensive understanding of a company’s business in order to avoid making the costly mistakes of a value trap. A stock price that looks promising on the surface may indicate something that the market knows.
Growth Versus Value Performance
Regarding price performance, it is clear that during the good times, growth stocks will outperform value stocks. However, when market conditions become tougher, value stocks tend to perform much better than growth stocks.
To reflect this, we show the performance of value stocks versus growth stocks in the US during the three years between 2020 and 2023.
(For reference, the S&P 500 is an Index that is split relatively evenly between growth and value.)
After the pandemic, with interest rates at rock bottom, there was fuel for growth stocks to massively outperform. However, once the Federal Reserve started to signal the tightening of interest rates in 2022, there was a considerable re-alignment in equity markets.
Growth stocks fell much harder compared to the relative safety of the high-quality value stocks.
Not Just Growth Or Value, But a Blend Of The Two
For the average investor, the trick is not to plump all your money into one area, such as tech stocks (high growth) or banks (value). Unless you are running a fund that has specific metrics and investing criteria to meet, the best idea for value funds is likely to lie in a blend of the two investing styles, investing in both value and growth stocks.
The key to a successful portfolio is diversification. That does not just mean holding 10 or 20 stocks with similar weightings. What if those stocks are all focused on a similar area?
Growth investing in a bear market is obviously a tricky thing. If you are invested entirely in growth stocks and there is a big turn lower in markets, you are likely to significantly underperform. Plus you will not be seeing too many dividends to help soften the fall.
This is why a successful (albeit arguably prudent) portfolio ideally needs to have a mix of value and growth stocks. This helps to add diversification. The growth stocks can help to propel your portfolio higher during the good times (your value stocks will likely go up too).
But when equity market conditions become tougher and returns are less positive, the value stocks can help to act as a safety buffer whilst also generating a decent income for the portfolio too.
Examples of Growth Stocks
Amazon is a technology and e-commerce giant known for its rapid revenue and earnings growth. It has expanded into various businesses, including online retail, cloud computing, and digital streaming.
Tesla is a prominent electric vehicle manufacturer that has experienced tremendous growth due to its innovative products and increasing demand for sustainable transportation solutions.
Netflix is a leading streaming service that has seen significant growth as it transformed the entertainment industry with its vast library of content and global subscriber base.
Salesforce is a cloud-based software company that offers customer relationship management (CRM) solutions. It has consistently shown impressive growth as businesses increasingly adopt cloud-based technologies.
Examples of Value Stocks
Johnson & Johnson (JNJ):
Johnson & Johnson is a healthcare conglomerate with a diversified portfolio of pharmaceuticals, medical devices, and consumer healthcare products. It is considered a value stock because it is often perceived as undervalued relative to its earnings and assets.
Procter & Gamble (PG):
Procter & Gamble is a consumer goods company that owns popular brands in various household and personal care product categories. It is considered a value stock due to its stable earnings and long-standing presence in the market.
Coca-Cola is a multinational beverage corporation known for its iconic soft drink brand. It is considered a value stock because it typically pays dividends and is viewed as a stable, established company.
Bank of America (BAC):
Bank of America is one of the largest banking institutions in the United States. It is considered a value stock due to its relatively low price-to-earnings ratio and potential for steady long-term earnings growth potential thereafter.
Growth Versus Value Investing Takeaways
Looking at long-term performance, neither the growth investment strategy nor value approach emerges as a clear victor.
Indeed, during favorable global economic growth conditions, growth stocks tend to slightly outperform value stocks. However, during economic downturns, both value and already outperformed growth stocks tend to take the lead.
As is often the case in life, extremes are not preferable. Opting for a balanced approach that includes exposure to both growth and value stocks can provide your portfolio with the best of both worlds.
Much of this decision relies on your time considerations: Where are you in the investor life cycle? How much time remains until your retirement? What is the current state of the economy?
There are pros and cons to investing in growth stocks and value stocks. We believe that there is room for both growth and value stocks in any portfolio.
However, deciding upon the mix of equity investments that you have in your portfolio can boil down to not only your tolerance for risk but also how accepting you are of potential drawdowns in performance. There is plenty to consider.
We should also mention that the line between growth companies and value companies is not always clear. For example you could make a compelling case that Apple is both a growth and value company.
Whatever approach you decide, good luck with your investing.