Let’s say you start looking out to plan your portfolio. You will want to combine different strategies and investment options. There are two main classic approaches that you need to consider in the mix - value investing vs growth investing. 

The experts at Wall Street generally classify stocks under the labels of value or growth. But in reality, there are many stocks that exhibit both elements. When creating a portfolio, it should have a blend of growth and value stocks. But, before you jump into choosing the different stocks, let’s understand what are value and growth stocks, and value investing vs growth investing.

Value vs Growth Investing - Table of Contents

What is Value Investing?

Value investors are always on the hunt for those hidden pieces of gold - stocks that are priced low but hold promise. The stocks are undervalued due to multiple reasons like a public relations crisis, or a recession in the industry. These investors buy stocks when they are underpriced and bet that the price will increase when others catch on. These stocks are generally known to have a lower price-to-earnings ratio but yield higher dividends. But there is a risk involved - the price might not appreciate as expected.

What are the Pros and Cons of Value Investing?

The following are the pros and cons of Value Investing:

Pros of Value Investing

• It generates higher profits. Value investing can generate spectacular returns.

• Lower risks with higher rewards. The risk-to-reward ratio is favorable when the stock evaluation is done properly.

• Based on profound fundamental analysis rather than emotions. Investors evaluate multiple metrics like P/E, and D/E that helps them arrive at the safe margin of a stock.

• Makes the most of compounding. If you reinvest dividends then returns increase exponentially.

• Value investors take into consideration the company rather than the stocks.

Cons of Value Investing

• Undervalued shares are difficult to identify as estimating the value requires expertise that not all investors possess.

• Value investing is a time-consuming process as sometimes investors need to hold their stocks for years.

• Waiting does not always lead to gains - In some cases owning stocks in a company can lead to gains, but it also can lead to a dead end. Investors can hold stocks for years but never see any returns. 

• Value investing investors need to be self-confident. This means they need to go against the flow of the market.

• Value investors can invest in all sectors that may underperform, but it is hard to make that prediction for the future. Committing funds to such sectors means a poor diversification of portfolio, which can lead to risks.

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What is Growth Investing?

Growth investors generally chase the market for high-risk stocks. If you’ve ever seen a disclaimer from a financial company then you know the disclaimer that past performances do not indicate future results. This is the exact opposite of what growth investment states. 

Investors bet that a stock that already highlights better-than-average growth continues to do so. This is why it is an attractive investment option. The companies which offer this stock are leaders in the market, and their stocks have an above-average price-to-earning ratio with low or no dividends. But, when investors buy these stocks at a high price, there is always an added risk that the stock prices could fall.

What are the Pros and Cons of Growth Investing?

The following are the pros and cons of Growth investing:

Pros of Growth Investing

• Provide a high rate of returns in long-term investment plans.

• Growth stocks are potential market leaders that provide constant returns which leads to an increase in earnings.

• Does not need a high capital investment and investors can slowly increase their exposure to these stocks when they get more funds.

Cons of Growth Investing

• These are high-risk stocks and are not ideal for investors with low-risk options.

• Virtually no returns or negligible returns from growth investing in the short term.

Growth Investing vs Value Investing - Historical Performance

When it comes to the comparison of the historical performances of value investing vs growth investing any result is evaluated in terms of the time and the volatility involved and the risks endured to achieve them. 

Value stocks are theoretically considered to have a low level of risk and volatility involved as they are a part of a larger company. Also, even if these stocks do not return to a target price that was predicted, it still offers some capital growth. These stocks are also known to pay dividends as well. 

On the other hand, growth stocks do not pay any dividend but instead reinvests the retained earnings to expand the company. The probability that growth stocks will incur a loss is greater, particularly when the company is not able to keep with the growth expectations. 

For example, let’s say a company is showcasing a product, but it is a dud. It is understandable that stocks will start plummeting when consumers use the product. Which is why in general, growth stocks have the highest potential rewards and risks for investors.

[ Learn How To Invest in Stocks For Beginners ]

Value Investing vs Growth Investing - Stocks Performance

The performance of Value investing vs Growth Investing has been debated by experts for decades. But in most cases, the performance of value stocks and growth stocks is cyclical in nature. The periodic out performance of each stock is observed when you compare Russell 1000 growth index with the value index.

What are the Differences Between Value Investing and Growth Investing?

How Do Growth and Value Investing Overlap?

Both Value investing vs Growth Investing have their own devoted followers, but there are multiple aspects where they overlap. Depending on your criteria, you will see stocks that are included in both. How is this possible? 

Realistically, nothing is set in stone. For example, a stock can evolve in its lifetime from value to growth, or vice versa. It is also important to know that investors in the value vs growth debate have the same goals, but they are just going about in different ways. 

Value investors generally look at those companies that already have their brand value, but the stock prices are lower than normal. On the other hand, growth investors look for companies with better future options and hope that the stock price will increase. Both investors are looking at the same destination, a higher return, but are choosing different paths to get there.

[ Check out How Does Stock Market Work? ]

When Should You Choose Growth Stocks?

• You do not see your investment portfolio as a source of income yet. This means that the money invested is not something you need right now.

• You understand that the goals set in growth stocks takes time to achieve. 

• You believe that you have picked the winning stocks in the competitive sector. Upcoming industries have hundreds of players vying for a share in the market. As a growth investor you need to understand the technology these companies are based on, while using your intuition to guide you. 

• You need to have a high-risk tolerance.

When Should You Choose Value Stocks?

• Your investments are part of your income. 

• You want to avoid value traps and prefer stable market prices. 

• You understand that a low stock price does not mean that a company is undervalued. Some stocks can be cheap for multiple reasons. As a value investor you need to understand when a company’s low evaluation indicates a shaky business. 

• You want your stocks to provide yields sooner rather than later.

Growth Investing or Value Investing - Which is Better?

When it comes to Value investing vs Growth Investing, the question of which style is better depends on multiple factors. Growth stocks perform better when interest rates are expected to stay low, but when rates increase investors shift to value stocks. Similarly, growth stocks in recent years have been performing well, but value stocks have a long-term record of growth. 

Growth Stocks Continue Outperforming Value Stocks: 

In the present market scenario, growth stocks have been seeing a nice increase. The last decade saw a rise in tech companies with massive opportunities. Big names such as Apple, Alphabet, Amazon, and Netflix now dominate the market share. Another major player in this industry is Microsoft. As per Ryan Johnson, CFA, director of Portfolio Management and Research at Buckingham Advisors, Ohio, in the last 5 years ending 2019, large-cap growth outperformed large-cap value by more than 30%. This happened as investors became fearful of short-term events that they were willing to pay higher rates for future years.

In Long term, Value Investing Tends to Outperform Growth Investing:

But even though in the short term growth stocks win the battle, value stocks tend to outlast the war. As per the data collated by Nobel Prize laureate Eugene Fama and Dartmouth professor Kenneth French, the compiled data from 1927 to 2019 showcases that the value stocks outperform growth stocks by 93%. But over a short period, value stocks outperform at lower rates.

When Will Value Outperform Growth Again?

The main question on the minds of investors is that when will value stocks will outshine growth stocks. The short answer is that no one knows. The long answer also is that no one knows. But experts do know that the market will change. One major sign to watch out for is inflation. Some traditional sectors that have outperformed are the rising energy prices that fueled the inflation and helped increase investors expectations for the higher interest rates. This rise helps boost energy and financial names in 2021, as the investors priced in higher profits in these companies.

Value Investing or Growth Investing - Which One to Choose?

When you look at the long-term performance, neither value nor growth stocks stand out the obvious winner. But it is true that when the economic condition is favorable then the growth stocks outperform value stocks by a smaller margin. But when the economy is in recession, value stocks perform better. 

But the economy moving into either extreme situation is not desirable. Being exposed to both value and growth stocks can help your portfolio perform better. But it depends on the time: Where are you in your investor life cycle? How much time till you retire? What is the state of the economy? 

Depending on these questions, choose an investment style that appears consistent with your goals. 

Conclusion

The decision to choose between Value investing vs Growth Investing is the ultimate decision depends on the investor’s preference, risk tolerance, time and investment goals. But, you need to remember that over short periods, the performance of growth or value depends on the market cycle. 

The debate of growth vs value will always continue, but the evidence suggests that the value stock will outperform better over growth stocks. If you plan on buying individual stocks, then stick to the fundamental investing principles that take the risk out of stocks.

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