financial investment

9 Things to Know About Growth Versus Value Stocks

Weigh the merits of these two competing investment styles.

The debate on whether value stocks instead of growth stocks will perform better in a portfolio has been long-standing. Growth stocks generate a higher than average expansion in sales and earnings and focus primarily on performance but can trade at a premium and with more volatility. Value stocks are viewed as underpriced based on company fundamentals. Owning both types of stocks can help investors avoid volatility, since the characteristics aren't always cut and dry. "Looking at each with a narrow scope is nearly impossible because growth is really a key part of the value equation," says Mike Loewengart, chief investment officer at E-Trade Financial. Here are nine ways growth stocks differ from value stocks.

Next:Momentum-driven market Credit

(Getty Images)

Momentum-driven market

Growth stocks typically perform well in a momentum-driven market like the current one, says Ron McCoy, CEO of Freedom Capital Advisors. "Often times their valuations are much higher in terms of price-to-earnings ratio and or price-to-sales compared to value stocks," he says. Growth stocks trade at higher multiples and experience more volatility and bigger price swings, McCoy says. The fundamental factors of defining value stocks include the book value-price ratio, earnings-price and sales-price, while growth stocks include metrics like price change momentum, earnings growth rates and sales per share growth rates, says Jodie Gunzberg, chief investment strategist of Graystone Consulting, a Morgan Stanley business.

Advertisement

Next:

Weigh the merits of these two competing investment styles.

The debate on whether value stocks instead of growth stocks will perform better in a portfolio has been long-standing. Growth stocks generate a higher than average expansion in sales and earnings and focus primarily on performance but can trade at a premium and with more volatility. Value stocks are viewed as underpriced based on company fundamentals. Owning both types of stocks can help investors avoid volatility, since the characteristics aren't always cut and dry. "Looking at each with a narrow scope is nearly impossible because growth is really a key part of the value equation," says Mike Loewengart, chief investment officer at E-Trade Financial. Here are nine ways growth stocks differ from value stocks.

Momentum-driven market

Growth stocks typically perform well in a momentum-driven market like the current one, says Ron McCoy, CEO of Freedom Capital Advisors. "Often times their valuations are much higher in terms of price-to-earnings ratio and or price-to-sales compared to value stocks," he says. Growth stocks trade at higher multiples and experience more volatility and bigger price swings, McCoy says. The fundamental factors of defining value stocks include the book value-price ratio, earnings-price and sales-price, while growth stocks include metrics like price change momentum, earnings growth rates and sales per share growth rates, says Jodie Gunzberg, chief investment strategist of Graystone Consulting, a Morgan Stanley business.

Interest rates fall

Growth stocks have the potential to perform better when interest rates are falling and company earnings are rising, says Michael Underhill, chief investment officer of Capital Innovations. "Value stocks, which are often in cyclical industries, may do well early in an economic recovery but are typically more likely to lag in a sustained bull market," he says. Growth stocks represent companies that have demonstrated better-than-average gains in earnings in recent years and are expected to continue delivering high levels of profit growth. Emerging growth companies have the potential to achieve high-earnings growth but lack a history of strong earnings growth, Underhill says.

Earnings growth

Growth stocks are known for high-earnings growth records, Underhill says. "While the earnings of some companies may be depressed during periods of slower economic improvement, growth companies may potentially continue to achieve high-earnings growth regardless of economic conditions," he says. Since growth stocks are higher priced than the broader market, investors will pay high P/E multiples with the "expectation of selling them at even higher prices as the companies continue to grow," Underhill says. The earnings of companies help differentiate between the two types of stocks.

Long-term investing

Value fund managers look for companies that have fallen out of favor but still have good fundamentals, Underhill says. Value stocks are priced lower than the broader market and below similar companies. Some value investors believe that a majority of these stocks are created due to overreaction of disappointing earnings, negative publicity or legal problems, which could raise doubts about the company's long-term prospects. Since value stocks also carry less risk than the broader market, these assets can take time to turn around. "Value stocks may be more suited to longer term investors and may carry more risk of price fluctuation than growth stocks," he says, with these stocks bouncing back in time.

Balance sheet

The predominant difference between growth and value stocks stems from balance sheet and valuation metrics, says Edison Byzyka, chief investment officer at Credent Wealth Management. Although growth stocks do not necessarily have weak balance sheets, valuations based on their balance sheet structure tend to be somewhat stretched. "As a result, relative to value stocks, growth stocks have higher price-to-earnings ratios, high price-to-book ratios and lower dividend yields," he says. The premise of value investing is simple: Less expensive companies tend to outperform more expensive companies in the long term, says Alejandro Saltiel, associate director of Modern Alpha at WisdomTree Investments.

Volatility

Growth stocks are also more volatile than the broader market, Underhill says. 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 Wall Street," he says. The amount of volatility signifies the difference between value and growth stocks, Byzyka says. Over the past three years, the annualized standard deviation for growth has been slightly higher than value stocks, experts say. "This isn't to say that higher standard deviation is an issue for those investors with a longer time horizon, but it's important to realize that downside can often reach the worst levels within growth equities," he says.

Falling U.S. dollar

Both growth and value stocks benefit more from a falling dollar than a rising one, based on monthly data year-over-year since July 1998, Gunzberg says. The dollar's value is based on debt levels, trade balances among other factors. But growth stocks are more sensitive to the dollar movements than value stocks. On average, large-cap growth rises 1.8 times more than large-cap value from a rising dollar and 1.3 times more from a falling dollar, according to research from Graystone Consulting.

Dividends

Value companies tend to pay dividends because they tend to be more established companies with less room to grow, but have consistent profits resulting in dividends, Loewengart says. On the flip side, growth companies tend to "hang on to cash and reinvest it back into the company rather than kicking it back to shareholders," he says. Investors shouldn't be lulled into a false sense of security that all value stocks offer income, he adds. "One risk to be mindful of is dividend payouts depend on company performance and the payout can change or cease each quarter," he says.

Sectors

Growth stocks are often found in the tech sector, which can be more volatile, while value stocks tend to be found in utilities and financials, Loewengart says. Sector exchange-traded funds can play a role and help dampen single-stock noise and focus more on the style of the stocks in the fund, he says. The bottom line is that diversification is key. There are a variety of growth and value mutual funds and ETFs available for investors such as the iShares Russell 1000 Growth ETF (ticker: IWF) or the Fidelity Blue Chip Growth Fund (FBGRX). Value investors can choose the Vanguard Value ETF (VTV), a large-cap passively managed ETF, or the Madison Dividend Income Fund (BHBFX).

There are a few differences between these two approaches to stock investing.

Momentum-driven market.Interest rates fall.Earnings growth.Long-term investing.Balance sheet.Volatility.Falling U.S. dollar.Dividends.Sectors.1 of 12

Ellen Chang, Contributor

Ellen Chang has been a contributing investing and financial writer for U.S. News & World ...  Read more

The Most Important Ages for Retirement Planning

ad content by  FidelityInvesting for Retirement: How to Design A Plan that Anticipates the Unexpected

Retirement

The Most Important Ages for Retirement Planning: Age 50

Retirement

The Most Important Ages for Retirement Planning: Age 59 ½

Retirement

The Most Important Ages for Retirement Planning: Age 65

Retirement

The Most Important Ages for Retirement Planning: Age 66

Retirement

The Most Important Ages for Retirement Planning: Age 70 ½


Leave a Reply