The terms value and growth refer to both two categories of stocks and two investment âstylesâ or approaches of investing in stock. Generally speaking, value stocks are shares of companies that have fallen out of favor and are valued less than their actual worth. Growth stocks are shares of companies that demonstrate a strong potential to increase revenue or earnings thereby ramping up their stock price.
Each style has pros and cons. When value investing, investors can buy shares of a company that has strong fundamentals at bargain prices. However, investors must be careful not to fall in a âvalue trapââbuying stocks that appear cheap, but are actually trading at a discount due to poor fundamentals.
When investing in growth stocks, investors bet that a promising company will beat out its competitorsâthough investors risk buying a stock that is valued too high. Hereâs a closer look at each style.
What Are Value Stocks?
When investors hunt for value stocks, they are looking for stocks that are cheap or unfashionable and arenât receiving a fair valuation in the market. Value investors try to identify value stocks by examining quarterly and annual financial statements and comparing what they see to the price the stock is getting on the market.
Investors will also look at a number of valuation metrics to determine whether the stock is cheap relative to its own trading history, its industry and other benchmarks, such as the S&P 500 index.
For example, investors often look at price-to-earnings (P/E), which is the ratio of price per share over earnings per share. Some specialists say that a value stockâs P/E should be 40% less than the stockâs highest P/E in the previous five years. Investors may also look at price-to-book, which is the price per share over book value per share. A stockâs book value is a companyâs total assets minus its liability and provides an estimate of a companyâs value if it were liquidated.
Value investors are hoping to buy a quality stock when its price is in a temporary lull, holding it until the market corrects and the stock price goes up to a point that better reflects the underlying value of the company.
What Could Make a Stock Undervalued?
There are a number of reasons that a stock could be undervalued.
• A stock could be cyclical, meaning itâs tied to the movements of the market. While the company itself might be strong, market fluctuations may temporarily cause its price to dip.
• An entire sector of the market could be out of favor, causing the price of a specific stock to dip. For example, a pharmaceutical company with an effective new drug might be priced low if the health care sector is generally on the outs with investors.
• Bad press could cause share prices to drop.
• Companies can simply be overlooked by investors looking in a different direction.
What Are Growth Stocks?
Growth stocks are shares of companies that demonstrate the potential for high earnings or sales, often rising faster than the rest of the market. These companies tend to reinvest their earnings back into their business to continue their companyâs growth spurt. Growth investors are betting that a company thatâs growing fast now, will continue to grow quickly in the future.
To spot growth stocks, investors look for companies that are not only expanding rapidly but may be leaders in their industry. For example, a company may have developed a new technology that gives it a competitive edge over similar companies.
There are also a number of metrics growth investors may examine to help them identify growth stocks. First, investors may look at price-to-sales (P/S), or price per share over sales per share. Not all growth companies are profitable, and P/S allows investors to see how quickly a company is expanding without factoring in its costs.
Investors may also look at price-to-earnings growth (PEG), which is P/E over projected earnings growth. A PEG of 1 or more typically suggests that investors are overvaluing a stock, while PEG of less than one may mean the stock is relatively cheap. PEG is a useful metric for investors who want to consider both value and growth investing.
Investors jumping into growth stocks may be buying a stock that is already valued relatively high. In doing so, they run the risk of losing a potentially significant amount of money if an unforeseen event causes prices to tumble in the future.
How Are Growth and Value Strategies Similar?
While growth and value investing are two different investment strategies, distinctions between the two are not hard and fastâthere can be quite a bit of overlap. Investors may see that stocks listed in a growth fund are also listed in a value fund depending on the criteria used to choose the stock.
Whatâs more, growth stocks may evolve into value stocks, and value stocks can become growth stocks. For example, say a small technology company develops a new product that attracts a lot of investor attention and it starts to use that capital to grow its business more quickly, shifting from value to growth.
Investors practicing growth and value strategies also have the same end goal in mind. They want to buy stocks when they are relatively cheap and sell them again when prices have gone up. Value investors are simply looking to do this with companies who are already on solid footing whose stock price should rise as a result. And growth investors are looking for companies with a lot of potential whose stock price will hopefully jump in the future.
Using Growth and Value Strategies Together
The stock market goes through natural cycles during which either growth or value stocks will be up. Investors who want to capture the potential benefits of each may choose to employ both strategies over the long term. Doing so may add diversity to an investorâs portfolio and head off the temptation to chase trends if one style pulls ahead of the other.
Investors who donât want to analyze individual stocks for growth or value potential can access these strategies through growth or value funds. Because of the cyclical nature of growth and value investing, investors may want to keep a close eye on their portfolios to ensure they stay balancedâand consider rebalancing if market cycles shift their asset allocation. For example, growth stock outperformed during the bull market that ended in 2020. This may have made some investorâs portfolios lopsided, causing them to rebalance into more value stocks or other investments, such as bonds.
Growth and value are different strategies for investing in stock. Investing in growth stocks is considered a bit riskier, though it also may provide potentially higher returns than value investing. That said, growth stocks have not always outperformed value stocks.
As a result, some investors may choose to build a diversified portfolio that includes each style so they have a better chance of reaping benefits when one is outperforming the other.
If youâre ready to start investing, SoFi InvestÂ® offers both active investing, for a DIY approach, and automated investing, for those who prefer to be more hands-off.
Find out how to get started with SoFi Invest.
The information provided is not meant to provide investment or financial advice. Investment decisions should be based on an individualâs specific financial needs, goals and risk profile. SoFi canât guarantee future financial performance. Advisory services offered through SoFi Wealth, LLC. SoFi Securities, LLC, member FINRA / SIPC . SoFi Invest refers to the three investment and trading platforms operated by Social Finance, Inc. and its affiliates (described below). Individual customer accounts may be subject to the terms applicable to one or more of the platforms below.
1) Automated InvestingâThe Automated Investing platform is owned by SoFi Wealth LLC, an SEC Registered Investment Advisor (âSofi Wealthâ). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC, an affiliated SEC registered broker dealer and member FINRA/SIPC, (âSofi Securities).
2) Active InvestingâThe Active Investing platform is owned by SoFi Securities LLC. Clearing and custody of all securities are provided by APEX Clearing Corporation.
3) Cryptocurrency is offered by SoFi Digital Assets, LLC, a FinCEN registered Money Service Business.
For additional disclosures related to the SoFi Invest platforms described above, including state licensure of Sofi Digital Assets, LLC, please visit www.sofi.com/legal. Neither the Investment Advisor Representatives of SoFi Wealth, nor the Registered Representatives of SoFi Securities are compensated for the sale of any product or service sold through any SoFi Invest platform. Information related to lending products contained herein should not be construed as an offer or pre-qualification for any loan product offered by SoFi Lending Corp and/or its affiliates.
Third Party Brand Mentions: No brands or products mentioned are affiliated with SoFi, nor do they endorse or sponsor this article. Third party trademarks referenced herein are property of their respective owners.
Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.
The post Value vs. Growth Stocks appeared first on SoFi.