Comparing Growth Stocks vs Value stocks: While investing in the stock market, one can choose multiple approaches to pick stocks as there are many types of stocks with different characteristics in the market. However, two popular types of stocks and approaches that investors prefer are growth investing and value investing. Both these growth stocks and value stocks are considered very important while building your stock portfolio. That’s why understanding the difference between growth stock vs value stock can help you to pick the right strategy.
Many times, while picking stocks you might have wondered why people are buying the stocks which are trading at a high valuation whereas conceptually most intelligent investors are looking for a low valuation and lower PE. The difference in the stock choosing strategy is itself contradictory and can be confusing for newbie investors who are picking stocks for the first time.
Therefore, today we are going to discuss growth stocks vs value stocks so that you can develop a clear understanding of these two approaches. In addition, we have a bonus investment approach in the later section of the article. Make sure you read the article till the end. Let’s get started.
Understanding Growth Stocks vs Value Stocks
What are Growth Stocks?
A Growth stock can be defined as a company that is growing at a very fast rate compared to its competitors and industry average. The growth is generally measured here in terms of their Revenue (Top Line) or Profits (Bottom Line), where these metrics can grow 3-5x or more within the last three to five years. However, many times the growth can also be considered in terms of how fast it is acquiring customers or how fastly it is getting more market share in its industry.
Growth stocks generally trade at a high valuation and you won’t be surprised to see the valuation even up to 100x PE for these companies. The high valuation of these stocks is justified with the earnings as they grow very fast year after year. Typically, the growths of these companies are around can be over 15-20% per year, while the rest of the nifty 50 stocks grow at an average of 3-7% per year.
A growth investor doesn’t care whether the stock is trading at a high valuation or above its intrinsic value as long as the company keeps growing its top line and the market price of those stocks keeps rising. As the growth and earnings of those companies are way higher than the peer companies, the investors expect those stocks to trade at a high PE valuation and are ready to purchase these companies at high prices.
What are Value Stocks?
The concept of value investing was popularized by Benjamin Graham (aka Father of Value Investing), back in the 1930s. In his famous book “The Intelligent Investor”, Ben Graham described the approach for a value investor, along with few other important concepts like Mr. Market & Margin of safety. If you want to build good fundamentals of value investing, we will highly recommend you to read the book- The Intelligent Investor by Benjamin Graham.
Value Stocks have completely different characteristics than Growth stocks. These companies do not have a very high growth rate, rather they grow slow. However, these stocks trade at a low valuation and low market price.
Value investors look at investing in stocks as buying the super cheap company which are trading below their true potential or true value in the market. They find the company’s intrinsic value using the fundamental approach of calculating valuations by reading its quarterly and annual reports.
The value investing approach is simple. The value investors look for an opportunity to buy a stock that is valued way less in the market than its true value and buys it. A value investor believes that this stock will rise to its true intrinsic value in the future when the market actually realizes it. They hold these stocks until the market value goes back to its true value.
There are a number of financial ratios that can be used to determine an undervalued stock in the market. Two of the most commonly used fundamental indicators are the Price to Earnings Ratio (PE Ratio) and Price to Book Value (P/BV) Ratio. Value investors prefer investing in stocks with a lower PE ratio and lower PBV ratio. (Also read: 8 Financial Ratio Analysis that Every Stock Investor Should Know)
Growth vs Value Stocks – Which one is Better?
Both value stock and growth stock investing approaches are effective ways to make money from the stocks. There is no fixed way of investing that you should choose and stick to it and depends mostly on the investor’s preference and knowledge.
Now, let us look into a few key differences between Growth stocks vs Value Stocks
|Growth Stocks||Value Stocks|
|A growth stock is bought at a fair to high price.||A value stock is bought at a discount on its intrinsic value.|
|They have a huge potential for future earnings and can give multi-fold returns||Earnings growth is small. However, the value investors make profits when the stock reaches its true intrinsic value.|
|They have a higher PE ratio and higher valuations.||Value stocks have a low PE ratio and lower valuations.|
|They give low or no dividends.||Value stocks give moderate to high dividends.|
Further, looking into the valuation of the Growth vs value stocks, we can use the PE ratio to describe the typical characteristics of both these stocks. Here is a general chart for the PE ratio of growth stocks vs value stocks vs industry, which can be common in most scenarios:
Now, when discussing which one is better among Value stocks vs Growth stocks, growth stocks can give multi-bagger returns to the investors, and the capital appreciation is not capped to the true value of the company. Here, the valuation can go higher and higher as long as the company keeps growing and maintains its fast growth rate.
On the other hand, value investing is a comparatively safer approach to investing as you’re buying stocks at discount to their true value which is always favorable. Moreover, these companies give good returns with stable dividends too.
Overall, defining which stock is better is not possible as it depends on the preference, risk factor, and stock picking strategy of the investors. However, it is advisable to keep a mix of value and dividend stocks in your portfolio to minimize the risk and maximize the returns.
Bonus: Dividend/Income Stocks
Dividend investing is the third approach to invest in stocks, apart from the value stocks and growth stocks. A dividend stock approach is investing in those stocks that pay high, regular, and consistently increasing dividends (Y-O-Y) to their shareholders.
The high dividend yield of these stocks mostly attracts this kind of investor rather than capital appreciation. The dividend yield of income stocks is higher compared to the peers in the industry and in the market. A few examples of dividend stocks in the Indian stock market can be Ex: Coal India, Indian Oil, REC, Hindustan Zinc, Bajaj Auto, Powergrid, etc
Anyways, while investing in a dividend stock, you should always choose a fundamentally strong company. Otherwise, if the profit decreases in the future, the dividends will decline too.
In addition, three more types of commonly popular stock categories worth mentioning here are:
- Blue Chip Stocks: These are large, well-established stable stocks with an excellent reputation. Ex: Reliance Industries, Asian Paints, HDFC Bank, TCS, etc.
- Cyclical Stocks: Stocks that are directly linked to the economy’s health and perform well when the economy is performing well are cyclical. Example: Voltas, Indigo, Hindalco, Tata Steel, etc.
- Defensive Stocks: Those Stocks that offer products/services that people always need and are recession-proof are known as defensive stocks. Example: Hindustan Unilever, Dabur, Zydus Wellness, Tata Consumer Products, etc.
In this article, we discussed the difference between Value stocks vs Growth stocks. Most successful investors have first studied both these approaches and then developed their own unique style. And you’re also recommended to do so, rather than blindly following any approach. Moreover, as mentioned earlier, it is advisable to keep a mix of value and dividend stocks in your portfolio to minimize the risk and maximize the returns.
That’s all for this post on Growth stocks vs value stocks. We hope it was helpful to you. Do comment below which investment strategy you prefer: Growth or Value investing, in the comment section below. Have a great day and Happy investing!
Hi, I am Kritesh (Tweet me here), an NSE Certified Equity Fundamental Analyst and an electrical engineer (NIT Warangal) by qualification. I have a passion for stocks and have spent my last 4+ years learning, investing and educating people about stock market investing. And so, I am delighted to share my learnings with you. #HappyInvesting