Growth and value are two fundamental approaches, or styles, in stock and stock mutual fund investing. Growth investors seek companies that offer strong earnings growth, while value investors seek stocks that appear to be undervalued in the marketplace. Because the two styles complement each other, they can potentially add diversity to your portfolio when used together.
Growth and Value Defined
Growth stocks represent companies that have demonstrated better-than-average gains in earnings in recent years and that are expected to continue delivering high levels of profit growth, although there are no guarantees. "Emerging" growth companies are those that have the potential to achieve high earnings growth but have not established a history of strong earnings growth.
The key characteristics of growth funds are as follows:
- Higher priced than the broader market. Investors are typically willing to pay high price-to-earnings multiples with the expectation of selling them at even higher prices as the companies continue to grow.
- High earnings growth records. While the earnings of some companies may be depressed during periods of slower economic improvement, growth companies may have the potential to achieve high earnings growth in different economic environments.
- More volatile than the broader market. The risk in buying a given growth stock is that its lofty price could fall sharply on any negative news about the company, particularly if earnings disappoint on Wall Street.
Value fund managers look for companies that have fallen out of favor but still have good fundamentals. The value group may also include stocks of new companies that have yet to be discovered by investors.
The key characteristics of value funds include:
- Lower priced than the broader market. The idea behind value investing is that stocks of good companies will bounce back in time if and when the true value is recognized by other investors.
- Priced below similar companies in the industry. Many value investors believe that a majority of value stocks are created due to investors' overreacting to recent company problems, such as disappointing earnings, negative publicity or legal problems, all of which may raise doubts about the company's long-term prospects.
- Carry somewhat less risk than the broader market. However, as they take time to turn around, value stocks may carry more risk of price fluctuation than growth stocks.
Growth or Value... or Both
History shows us that:
- Growth stocks, in general, have the potential to perform better when interest rates are falling and company earnings are rising. However, they may also be the first to be punished when the economy is cooling.
- Value stocks, often stocks of cyclical industries, may do well early in an economic recovery but are, typically, more likely to lag in a sustained bull market
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