Value vs. growth investing both involve looking for stocks that are priced below the likely strength of the underlying company with the goal of capturing the asset’s eventual gains.But the key difference between value vs. growth investing is that value investing is a long-term strategy, while growth investing is a short-term strategy. A value strategy is for building wealth over a period of years and maintaining that wealth through stable assets.A growth strategy is for building wealth over a period of months, at the risk of the volatility that comes with high-potential assets.
Not sure whether to use value vs. growth investing in your own portfolio? A financial advisor can help you decide.
What Is Value Investing?
Value investing is the practice of investing in “value stocks.”
A value stock is one that has a low price relative to the underlying company’s intrinsic value. With this strategy, you’re looking for stocks where the company is well-established and strong, but the share price doesn’t necessarily reflect the extent of the underlying company’s strength. This is otherwise expressed as a stock with a high book-to-market value.
In addition to strong book-to-market value (that is, a company with a high net asset value compared to its market capitalization), a few other features tend to characterize value stocks:
- Value stocks tend to be relatively stable.
- They often have a low price-to-earnings ratio.
- They typically pay dividends.
The overall profile of a value stock is that of a well-established, successful company that the market has overlooked.Value investing is the practice of buying these stocks for value and using them to build a portfolio.
When Should You Use Value Investing?
Value investing is typically used for several investing strategies:
- It’s a good foundation for a stable, long-term investing strategy. A value stock is one that you think will steadily gain value over the long run. These stocks are characterized by their low volatility. While they likely won’t provide exceptional gains, value stocks typically grow over the long term.
- Value stocks are often a good way to approach income investing. They’re characterized by strong underlying companies, which often correlates with dividend payouts. The stability of a value stock means that those dividends are likely to continue, rather than be presented as special dividends or short-term payouts. A portfolio of dividend-paying value stocks can be an attractive option for high-value income investors who want to purchase equities over bonds.
- Value investing often thrives during a strong economy.Value stocks tend to do well when demand is high, and can hold their value well during periods of rising inflation and interest rates. This is due to the established nature of the underlying company, which will be less affected by swings in the cost of capital and production. Having already established their business and supply network, value companies will typically be well-poised to take advantage of consumer demand while being less exposed to higher costs of growth.
What Is Growth Investing?
Growth investing is the practice of investing in “growth stocks.”
Where value stocks are assets that represent a strong underlying company, growth stocks tend to represent a business that has not yet been established. With a growth stock, the share price may be representative of the firm’s current value, or even comparatively high. Either way, it’s often based on the assumption that the company is poised for significant growth and a much higher share price to come. With growth investing, investors are often seeking out undiscovered companies, startups or emerging businesses, and are looking for big, short-term gains as the company explodes in value.
These are stocks that have a low book-to-market value. In other words, the company hasn’t taken full advantage of its capital yet, and is poised to turn that investment into growth and cash flow in the near future. Growth stocks are also known to be volatile, with relatively high share prices and price-to-earnings ratios. These are ideally undiscovered gems, trading at low price points, that are preparing to use their capital.
When Should You Use Growth Investing?
Growth investing is typically used for two portfolio profiles:
- Risky, short-term investing. A growth stock is one that you think might gain a lot of value in a relatively short amount of time. Since a successful growth stock will gain its value in the near future, investors want to get in before the moment has passed. As growth stocks are characterized by higher volatility and higher risk, growth investing can lead to a much higher chance of loss. This makes growth stocks a potentially good fit for the speculative side of an investor’s portfolio.
- Investing in a down market. Growth stocks tend to perform better in weaker markets, where inflation and interest rates are low. This is because they represent underlying companies that are looking to put capital to use. These companies are less worried about weak demand, since they’re still building out their consumer-oriented functions, and are better poised to take advantage of inexpensive money and production costs. As a result, downturns are often characterized by strong opportunities for growth investing.
Bottom Line
Value investing is often best used for a long-term portfolio, and for investing during a strong economy. Growth investing is often best used for a short-term, high-speculation portfolio, and for investing during a down economy. Knowing how to choose among value vs. growth stocks can help you make the right decision for your portfolio.
Tips on Value vs. Growth Investing
- Increasingly, retirement advisors are recommending that households keep a large section of equities in their portfolio well into retirement. The upshot of this is that, no matter where you are in life, it’s worth learning how to invest in stocks.
- A financial advisor can help you build a comprehensive retirement plan. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you canhave a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
Photo credit: ©iStock.com/nespix, ©iStock.com/BongkarnThanyakij, ©iStock.com/Kobus Louw
