Among the options you might consider are growth stocks and value stocks. 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 mix of the two in your portfolio.
Growth stocks versus value stocks
There are many differences between growth stocks and value stocks. Each of these asset types offers valuable benefits and drawbacks that deserve careful consideration. 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, generating above-average returns over the long term. Growth stocks are usually from companies or industries that are expected to expand. Since these stocks are expected to perform well, you may pay a premium for them.
“Growth stocks are those that have a strong potential to outperform, mostly due to the potential for stronger earnings growth,” says Kevin Gordon, chief investment strategist at Charles Schwab. “They are often considered ‘super fliers’ due to their occasional significant outperformance, such as during the technology boom of the late 1990s. But with that comes increased risks when a downturn approaches.
Value stocks: On the other hand, value stocks are stocks of companies that are considered undervalued for one reason or another. As such, these shares are trading at a discount compared to the company’s assets.
“Value stocks trade at undervalue and are often viewed as hidden gems in the market,” says Gordon. “Many (but not all) value stocks tend to correlate with 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?
Growth stock is a share of a company that is expected to grow at a rate higher than the average growth rate in the market. Companies that fall into this category generally prioritize rapid growth, whether that is increasing revenues, developing new products, expanding market share, or moving into new geographies.
Another advantage of growth stocks is that they are usually expensive. Its stock price is usually high compared to current earnings. These stocks are also considered riskier by some measures because there is no guarantee of future success.
Pros and cons of growth stocks
There are many benefits associated with growth stock investments, but these assets are not without risk.
Pros
- May outperform the market: Growth stocks are expected to grow at a rate higher than the market average.
- Capital gains: The value of these shares is expected to increase over time, which the owner can benefit from by selling the stock once its value increases.
cons
- beloved: Growth stocks are usually expensive, especially in relation to their current dividends.
- Higher risks: These stocks can be volatile and have the potential to crash, which could be a costly failure since they are typically expensive assets to buy.
- No short term returns: Yields from growth stocks require patience because they take time to grow in value.
What are value stocks and how do they work?
A value stock is any stock in a company that is trading at a level that is perceived to be below its intrinsic value and, therefore, there may be value to be found.
“Value-oriented companies are typically older, more established, with proven track records of success,” Gardner says. “Value stocks can be classified by high levels of profitability and consistent, albeit lower, growth.”
Some examples of value stocks include Target, Exxon, and Bank of America, all of which are large-scale companies with decades of proven success.
Another important point about value stocks is that compared to growth stocks, these companies typically prioritize free cash flow and returning dividends to investors, providing income in the form of dividends or stock buybacks rather than aggressively reinvesting that money back into the business.
“Value investors can expect to benefit from both earnings (income) and moderate levels of stock price appreciation as the market better values these earnings streams over time (growth),” Gardner explains.
Pros and cons of value stocks
Pros
- Providing income: Unlike growth stocks, value stocks may provide near-term income in the form of dividends.
- Undervalued: These stocks tend to be undervalued or relatively inexpensive when compared to the perceived value of the company.
- Less volatile: Value stocks are typically more established companies with a history of providing bear market protection.
cons
- Take more time to estimate: Value stocks can take several years to grow in price and therefore require patience.
- Possible dead end: There is no guarantee that stocks will ever rise in value.
- Challenge to recognize: Finding a true value stock, one that is currently undervalued and may rise once there is a market correction, requires an experienced 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 and expensive, and take time to reach their full potential. As such, they may be best used in pursuit of long-term financial goals. On the other hand, value stocks tend to be more consistent in terms of earnings, less risky or volatile, and often provide a good option for earning higher income in the short term.
However, when considering value and growth stocks, you don’t necessarily need to choose one or the other. In fact, some experts suggest that a well-diversified portfolio will include a balance between the two.
“The winning portfolio includes a long-term allocation to premium growth companies and an allocation to less volatile, more consistent, value-oriented companies,” says Joe Percoco, co-founder and co-CEO of Titan.
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