Have you heard about the debate? No, I am not talking about a political debate. I am referring to the age old market debate on growth stocks versus value stocks. It is human nature to want to acquire something at a low price. We just like to buy things on sale. I can relate to you that on days when the stock market is down significantly, I wander onto the trading floor and listen to the conversation the traders are having with their clients. I often ask some of them whether clients are panicky or confident. Most importantly, I ask if clients are generally buying or selling. And wouldn’t you know, most of them are excited… and… buying. These are, of course, investors trying to capture value by purchasing stocks which are on sale. In fact, there is a whole group of stocks which could be classified as being fairly priced, and those are Value Stocks. Interestingly if you speak to an average investor, though they inherently understand the value investing style, they rarely mention what would be considered a classic value stock. Instead, they talk about what would be considered classic Growth stocks, and for good reason. Growth stocks have created an enormous amount of wealth in the past few decades. Go on, think of some of your favorite stocks. I can wait. Still waiting. Ok, I would bet that a strong majority of those stocks you are thinking about are growth stocks. In the wake of the pandemic, recovery, and the Fed’s harsh monetary tightening, notable frontrunners went from growth, to value, to growth, back to value, and a recent resurgence of growth. All this has probably gotten you somewhat confused between growth and value stocks, so let’s go through the basics today.
Growth stocks are shares of companies that demonstrate a high potential for above-average revenue and earnings growth relative to the overall market. These companies are typically in their early stages or are operating in rapidly expanding industries. Investors are attracted to growth stocks because they offer the prospect of substantial capital appreciation over time.
Growth Stocks Characteristics
• Earnings Growth - Growth stocks are known for their impressive earnings growth rates. These companies often reinvest (or plough back) their profits into the business to finance expansion and innovation, rather than distributing them as dividends.
• High Valuations - Due to their strong growth prospects, growth stocks are often associated with higher valuations, as reflected in elevated price-to-earnings (PE) ratios.
• High Volatility - Growth stocks can be more volatile than other types of stocks due to their higher risk-reward profile. Price swings can be significant, leading to potentially substantial gains… or losses for investors.
Investors seeking to invest in growth stocks often employ a buy and hold strategy. They look for companies with solid growth potential, innovative products or services, and solid management teams. The focus is on long-term capital appreciation, and investors are willing to endure short-term price fluctuations to benefit from the stock's potential to grow over time.
Growth Stocks Risks
• Market Sentiment - Growth stocks can be influenced by market sentiment, leading to sharp price movements based on short-term news and investor perceptions.
• Heightened Expectations - The success of growth stocks is often contingent on meeting or exceeding high market expectations. Failure to deliver on anticipated growth can lead to significant price declines.
Value stocks represent shares of companies that are perceived to be undervalued relative to their intrinsic value. These companies might be experiencing temporary setbacks or are in industries that are currently out of favor with investors. Value stocks attract investors looking for potentially undervalued assets, things on sale, that could experience price appreciation as market conditions improve.
Value Stocks Characteristics
• Undervaluation - Value stocks are characterized by lower price-to-earnings (PE) ratios and other valuation metrics relative to the broader market. This suggests that the market has not fully recognized their true worth.
• Dividends - Value stocks often pay dividends, providing investors with a steady income stream, even during periods of slower growth.
• Lower volatility - Value stocks tend to be less volatile than growth stocks, making them attractive to conservative investors seeking capital preservation.
Value investing involves identifying companies that are trading at a discount to their intrinsic value. Investors search for stocks with solid fundamentals, such as strong cash flow, low debt levels, and stable earnings. The goal is to buy these undervalued stocks and hold them until their market value reflects their true worth.
Risks of Value Stocks
• Value Traps - Some value stocks may be undervalued for the right reasons, such as poor management or declining industries. Investors risk falling into value traps where the stock remains stagnant or continues to decline.
• Market Timing - Identifying the right time to invest in value stocks can be challenging. They may remain undervalued for an extended period before the market recognizes their potential.
Historically, growth stocks have outperformed value stocks during bull markets, periods of economic expansion, and low-interest-rate environments. Growth stocks' strong earnings growth and potential for capital appreciation have attracted investors seeking high returns. However, during bear markets and economic downturns, value stocks have shown resilience and tend to outperform growth stocks due to their stable dividends and lower volatility. Check out the following chart which shows the relative performance of Growth to Value stocks since 2010. You will note that the tangle between the two different styles is very real, but overall, the trend winner is Growth. However, before you jump to conclusions one way or another it is important to note how significantly value overtook growth in 2022. That is the result of growth losing significantly more than value during that phase. You can also see growths recent outperformance year to date. This chart displays a wide timeframe, but you can check out the same chart over the past 12 months, every day. It is chart number 14 in my daily chart-book, which is attached to my daily market note. If you are not signed up to receive it, you can sign up here.
In conclusion, the choice between growth stocks and value stocks largely depends on an investor's risk tolerance, investment horizon, and the market outlook. Growth stocks offer the potential for significant capital gains but come with higher volatility and elevated valuations. Value stocks, on the other hand, are associated with lower valuations and can provide stability in turbulent markets, although they may require patience for their true value to be recognized. Ultimately, a diversified portfolio that combines both growth and value stocks may offer a balanced approach to achieve long-term financial goals. With careful consideration, investors can navigate the growth stocks vs. value stocks debate and optimize their investment returns.