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Growth stocks, like Apple and Tesla, tend to be more volatile but have the potential for higher returns.
SrdjanPav/Getty
Value stocks tend to be less volatile than growth stocks and perform better in bear markets.
Growth stocks historically outperform value stocks in bull markets.
Value stocks generally pay higher dividends than growth stocks.
Growth stocks are shares of companies that are expected to experience high growth rates in both their revenue and returns to investors.
Value stocks, on the other hand, are shares of companies that trade at a lower price relative to the company’s financial performance.
Both have their own advantages and disadvantages, and perform differently based on where the economy is in the business cycle. But which one is right for you and your portfolio? Let’s take a closer look at each investing strategy to understand whether they could be a fit for your goals.
Value stocks vs. growth stocks: At a glance
Growth stocks are those that investors believe will have higher-than-average returns in the short term, while value stocks are those that investors feel are overlooked by the market at large.
Another way of looking at the difference between the two: Growth stocks would be the expensive designer jacket, value stocks would be the jacket at the thrift store.
Value stocks are measured and defined by their financial performance, such as sales, earnings, and select financial ratios. Growth stocks are more volatile than value stocks, but they also have the potential to generate higher returns.
What are value stocks?
Value stocks are often defined as those that trade below their intrinsic value. A stock’s intrinsic value is the price calculated based on the future growth of the company or the amount of assets and liabilities the company currently owns.
For example, if a company’s intrinsic value is $100 per share but it is currently trading at $80 per share, it could be considered a value stock.
Billionaire Warren Buffett, through his holding company Berkshire Hathaway, is one of the most prominent value investors. Value stocks generally outperform growth stocks during periods of market volatility or when the economy is weak. This is because value stocks are often seen as a safe haven during times of economic uncertainty because they are older and more established.
Quick tip: There are several ways to calculate a stock’s intrinsic value. One of the most popular methods is the discounted cash flow (DCF) approach, which estimates the future income of the company and adjusts that figure into today’s dollars.
“Sectors commonly associated with value stocks include financials, energy, or industrials,” says Kyle McBrien, a CFP® professional at Betterment. “These companies are generally able to pay out higher dividends to shareholders than their growth counterparts because their products and services don’t require as much reinvestment.”
However, value stocks have become increasingly scarce. According to data from Charles Schwab and Bloomberg, there were about 75 value stocks in the S&P 500 in September 2022. In 2012, there were more than 125 value stocks.
Here are some pros and cons of value stocks.
Pros
Cons
Generally do well when the market is in a downturn
Tend to be much less volatile than growth stocks
Historically have higher expected returns than growth stocks over the long term
More likely to pay dividends
May be harder to find as the number of value stocks shrinksMay take much longer to see profits compared with growth stocksMore difficult to calculate a company’s valueMost value stocks are already in a downtrend and may continue to fallMay not provide adequate portfolio diversification
Example of value stocks
S&P Global is the company that created and monitors the S&P 500 index as well as its variations. In 1992, S&P Global created the S&P 500 Value Index, measuring value stocks using the financial ratios of book value, earnings, and sales-to-price.
Both Coca-Cola and Procter & Gamble are defined as value stocks under the S&P Global’s criteria. Additionally, both companies have paid an increasing dividend for at least 60 years.
Note: Depending on changes in the stock market as well as price changes within individual companies, what may be considered a growth or value stock today is subject to change over time.
What are growth stocks?
Growth stocks, as the name implies, are those that have a higher-than-average return compared to the broader stock market.
S&P Global determines growth stocks by a company’s sales growth, the ratio of earnings change to its price, and momentum. A stock’s momentum is the speed at which its price rises or falls. Growth stocks tend to be concentrated more in the health-care and technology sectors in comparison to value stocks. The founder of Ark Invest, Cathie Wood, is one of the most well-known investors who follows the growth investing methodology.
“Growth stocks tend to perform better in low interest rate environments,” says Nikki Dunn, a CFP® professional and founder of She Talks Finance. This is because these companies can borrow cheap capital to finance their growth. The opposite is true, however, when the economy is experiencing a slowdown and interest rates rise, increasing borrowing costs for growth companies.
Pros
Cons
Higher potential for gains in the short term
Generally perform better than value stocks in bull markets, which historically occur more often than bear markets
Typically easier to find and identify compared to value stocks
May not provide enough diversification as growth stocks are concentrated in the technology sectorGenerally more volatile than value stocksHistorically do not perform well in economic slowdowns or when interest rates are risingLess likely to pay dividends
Example of growth stocks
S&P Global defines value stocks using sales growth, momentum, and the ratio of earnings change to price. Current companies that are considered growth stocks are Apple and Tesla. Over the last decade, both have become well known for their track records of high returns.
Quick tip: Exchange-traded funds (ETFs) focused on a growth or value index can be a quick and efficient way to add these stocks to your portfolio without the guesswork of choosing individual stocks.
The bottom line
Attempting to time the market and choose the right moment to invest in a growth stock versus a value stock — and vice versa — can be difficult. As with all investments, you should consider your appetite for risk as well as your time horizon when comparing growth to value investing approaches.
“There are times where one style may be more favored in the market,” Dunn says. “I think they both have a place in a portfolio to stay diversified.”