Know the Difference: Growth Versus Value Investing

As a long-term investor, it helps to create a diversified portfolio while drawing a balance between the two investment styles: growth and value. 

Growth investing focuses on companies that demonstrate or are expected to have high growth potential. On the other hand, in value investing, an investor searches out undervalued companies that may not be currently growing at a faster pace but are fundamentally strong stocks that are likely to witness a spike in value over time. 

Growth investing relates to making investments in stocks of companies that have significant potential for growth in the future. This is irrespective of the fact that such stocks are currently trading at a high price relative to their current earnings or book value. The focus is on investing in companies with high earnings growth potential and high price-to-earnings (P/E) ratios, instead of searching out for undervalued companies.  

A few examples of growth stocks include information technology and information technology-enabled services (IT/ITeS) companies, biotechnology companies and emerging market companies. 

Similarly, value investing is related to investing in companies that are at the moment trading at a discount relative to their intrinsic value. This is even if they are not necessarily growing at a faster pace than growth companies. Value investors tend to search out for companies with low P/E ratios, low price-to-book (P/B) ratios and high dividend yields, considering such factors suggest the company may be undervalued by the market.  

A few examples of value stocks include utility companies, consumer durables and financial organisations.

Some of the key differences between growth and value stocks include: 

Growth stocks involve companies, which are expected to grow at a relatively faster pace than the overall equity market. On the other hand, value stocks are companies that are undervalued by the equity market. This means that their stock prices are less as compared to their fundamental value. 

Growth stocks tend to have high P/E ratios, reflecting the high expectations for future earnings growth. Value stocks have significantly low P/E ratios, highlighting the market’s low sentiments related to their earnings growth potential. 

Growth stocks are likely to pay no or low dividends or considering they are reinvesting earnings to promote growth in the future. Value stocks are most likely to pay higher dividends in an effort to draw investors. 

Growth stocks are characterised by high volatility and are more likely expected to experience sharp price movements, while value stocks are comparatively quite stable and tend to experience low volatility. 

In general, growth stocks may be a suitable investment option for young and aggressive investors with a long investment horizon and who are willing to pay a premium. Such investors are comfortable while taking higher levels of risks and have a high tolerance for market volatility. 

In a similar vein, value stocks may be good investment options for conservative, income-oriented investors or retirees who remain risk-averse, considering value stocks typically have low P/E ratios, low P/B ratios and high dividend yields.