There are many routes that can lead investors to success, but two of the most popular are growth and value investing.
Value investing means buying shares of companies that you believe are undervalued, relative to their industry peers, in the hopes of finding a bargain. Meanwhile, growth investors often pay a premium to buy the fastest-growing stocks because they expect these stocks will continue to outpace the broader market.
You may have seen investment choices in your 401(k) that have a value or growth objective spelled out in their name — index funds that adhere to these investing styles are common offerings in workplace retirement plans.
The universal goal for most investors is to buy at a low price and then sell higher down the road. With value investing, you're looking for more than just a low price, though. You're trying to find stocks that are undervalued and seem underpriced either relative to competitors or the broader market — and have promising business prospects ahead.
While "value" can be a subjective term, there are some common ways investors assess it. The overseers of the S&P 500 have split up the broader index into growth and value subcomponents. Value stocks are selected based on the following metrics:
- The stock's price relative to the company's book value, meaning total assets minus liabilities
- The stock's price relative to the company's earnings, or profit
- The stock's price relative to the company's revenues
Value investors want to see low ratios on all three measures. That indicates the stock is underpriced relative to the company's value, profit, and sales potential.
Many investors are familiar with the concepts of value investing thanks largely to its most famous and ardent proponent: Warren Buffett, chairman of Berkshire Hathaway. He regularly shares the simple ways he decides what companies to invest in, along with his broader investing advice.
Unlike value investing, growth investors knowingly pay a premium for stocks because they believe these stocks will continue to perform better than the market. So instead of hunting for hidden gems, these investors bet that the fastest-growing companies will keep up the pace.
The overseers of the S&P 500 index measure growth based on:
- How fast a company's sales are growing
- How much earnings are changing in relation to the stock's price
- Momentum, or how rapidly a stock's price is accelerating
Investors use these metrics to see if a company's growth and profit are accelerating in recent years, along with its stock price.
You may have heard the Wall Street acronym FAANG, which stands for Facebook, Amazon, Apple, Netflix, and Google parent Alphabet. These stocks have been among the best performers in the market and have become synonymous with the definition of growth stocks in recent years. But that distinction may not last — and that's not necessarily a bad thing. It's healthy for new entrants to emerge.
While value and growth investors may take different routes, both have proven long-term success. That's why experts recommend having some mix of both investing styles in your portfolio.
While growth stocks have performed better than value stocks in the past decade, thanks in large part to those aforementioned tech stocks, these dynamics can shift. Over shorter time periods — like the past three months, for example — value stocks are actually performing better than growth stocks, according to data analyzed by Grow. That said, some traders view a shift in favor of value stocks as a warning signal of slower economic growth ahead.
Whether you find yourself more intrigued by one investing philosophy over the other, the good news is you don't have to do the legwork of picking individual stocks. There are a variety of exchange-traded funds and index funds that identify value and growth stocks, making it easy to earmark some portion of your portfolio to either style of investing, or to both.
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