You might come across the terms "growth" and "value" stocks, but what do they really mean? While there's no strict definition, experts generally agree on certain characteristics that distinguish these two types of investments. Understanding these differences can assist you in choosing the type that fits your portfolio or using them for diversification.
Growth stocks share certain traits, although individual investors may adjust the specifics based on their needs. There are a couple of signs you could observe that indicate a stock is a growth stock:
A good stock should show a solid expected growth rate in the future, and it's essential to consider its historical performance too. Ideally, you'd like to observe past growth rates of 10% or more for smaller companies over the last five years and look for rates between 5% and 7% for larger firms.
Growth investing is about selecting stocks that are currently growing and have the potential for ongoing growth. On the other hand, value investing involves identifying stocks that the market has undervalued, with the expectation that their value will increase if the market corrects its pricing.
It's better to see similar growth rates or more in a company's forecasted five-year growth rate. Large companies often don't grow as quickly as smaller ones, so consider their size, age, and performance.
Return on equity (ROE) gauges how well a company utilizes investor money and allows for industry-wide comparisons. This helps you assess how the company's ROE compares to its competitors.
Earnings per share (EPS) measures the profit generated for each stock share. Growing EPS with a stable number of shares indicates increased capital generation.
Earnings before taxes (EBT), also known as "pre-tax margin ratio," reflects a company's operational efficiency. Consistently surpassing past averages and industry benchmarks indicates growth.
Financial analysts predict stock prices based on a company's business model, market position, economic trends, and investor sentiments. You can find these projections on stock exchange websites.
Remember, a stock may not meet all the mentioned criteria and still be a growth stock. For example, it might lack a five-year history but could be a significant player in a rapidly growing industry.
Value stocks might not always be inexpensive, but a good place to find them is among stocks hitting their lowest prices in a year (52-week lows). Investors consider value stocks as potential bargains.
The prices of value stocks are low because the market has underestimated them for different reasons. The strategy is to invest before the market adjusts the price. Here are some indicators to consider when looking at a value stock:
If a stock's price-to-earnings ratio is in the lowest 10% among all company stocks, it's considered undervalued. This makes it a value stock because the price is likely to increase in the future.
When a stock hits its lowest price in a year (52-week lows) and has a high debt-to-equity ratio compared to the industry average, it might be entering a growth phase. However, be cautious with this ratio, as it could indicate the company has an unsustainable level of debt.
The current ratio assesses a company's ability to settle short-term debts using current assets. Current assets are assets that can be sold or converted into cash within the next year. Short-term obligations are debts due within the next year.
A company can use current assets, like selling or converting them to cash, to handle short-term debts. The current ratio indicates how smoothly this process can happen. If the ratio is less than one, it suggests that the business may struggle to meet its debt obligations.
Tangible book value is the worth of a share as stated on the latest balance sheet. If a stock's share price is lower than the company's book value, it could be undervalued and may be due for a market correction.
There have been times, like in the late 1990s, when growth stocks have done well. There are other periods when value stocks outperformed growth stocks. You should hold both to diversify your portfolio and hedge risk.
Both growth and value stocks come with their own risks. Growth stocks might be volatile and not grow. Value stocks might not gain momentum and suffer a collapse. Choosing the right one is about more than just ratios or past performance.
When comparing growth or value stocks, think about a few different things: how long the company has been operating, the conditions of the market and industry, and the level of risk you're comfortable with. As the market, economy, and investor sentiments change, the risks change as well. Diversification helps you stay afloat in the wild sea of investing.
A diversified portfolio has both value and growth stocks. If yours only has one kind, consider the main benefit of diversification: mitigating risk. If you are just getting started, plan your portfolio to have a good mix of value and growth stocks.
Stock screeners help you easily sort through the whole stock market to find investments that match your criteria. Many brokerages include a screener in their trading software, or you can use third-party screening services. If you're looking for value stocks, you can use filters like P/E ratio to narrow down your options and identify potentially undervalued companies.
In the past, Apple was clearly seen as a growth stock because it was rapidly expanding. However, as Apple became a more significant part of the overall stock market, the situation evolved. Now, analysts may have different opinions – some see it as a growth stock, some as a value stock, and some as a bit of both. For example, Morningstar analysis categorizes Apple as part of the "large core" stocks, displaying traits of both growth and value companies.
