One of the oldest debates in the history of investing is the value vs growth argument. Each has had their period in the sun—value stocks outperformed in the time leading up to the Great Recession, but growth stocks (especially in the tech sector) have demolished the competition over the last decade.
But investors aren’t interested in what different asset classes have done in the past—it’s where we think stocks are going in the future that intrigues market participants. And while growth stocks, particularly in the tech realm, have benefitted from the new COVID-induced economy, how much longer will they dominate the market? Before investing in either growth or value, it’s important to learn the benefits and drawbacks of each asset class so you can understand what’s right for you.
If you’re looking for assistance in creating a personalized financial plan, speak with a CERTIFIED FINANCIAL PLANNER™ professional at Good Life Financial Advisors of NOVA today!
What are Growth Stocks?
Growth stocks describe exactly what they’re concerned with right away—growth. You can think of them as the race horse in a portfolio. When investing in growth stocks, you’re looking for companies that are increasing revenues each year while gaining a larger and larger footprint in the market. Oftentimes, growth stock investors are less concerned with fundamental data like Price-to-Earnings ratios or gross margins. For growth stock investors, it’s all about how fast a company may be able to grow currently and in the future.
Often, growth stocks may not even have earning! Investors seeking growth stocks will look at numbers like year-over-year revenue expansion and a company’s ability to transform the way we live—their ability to transform an industry.
Pros and Cons of Growth Stocks
Below are some of the pros and cons of growth stocks:
Pro: Growth stocks can be home runs
In early stages of a bull market investor sentiment gets rosy and growth stocks are often primed to perform well. We’ve all heard of investors who have bought into a growth company early and have had some incredible performance in their portfolio.
Con: Growth stocks can be awful strikeouts
Growth stocks do tend to outperform the market in good times, but even the most profitable growth stock can be prone to bouts of volatility. Not only that, growth investors typically are paying more for a company based on what it may do in the future. Should that future growth not happen, the stock price can come crashing down. If volatility makes you sweat, growth stocks might be a bad investment for your blood pressure.
Pro: Defer the tax bill while your wealth grows
You don’t pay taxes on the built-in appreciation of a security until you sell it. So, if you don’t need the money, you can let your investment grow and grow. Even though your net worth is growing, you don’t have to pay taxes on that growth, because it is not considered a capital gain until the time of sale. Then, when it is time to sell, your advisor can help you develop a tax efficient distribution strategy.
Con: Growth stocks don’t pay dividends
One of the reasons investors shy away from growth stocks is the lack of consistent income provided through dividends. While more established and less growth-focused firms return profits to shareholders in the form of dividends, growth stocks tend to reinvest those extra profits into the company to increase research and development or buy new equipment.
What are Value Stocks?
Value stocks are the “plough horse” companies that investors buy because, while not fast growers, they’ve had a record of consistently providing a positive return on investment (ROI) for shareholders. Value stocks might not pace the returns of growth stocks, but they can provide solid returns with less uncertainty than growth stocks.
Investors looking at value stocks focus on fundamentals like earnings, debt levels, margins, and sales. Growth stocks are also concerned with earnings and sales, but value stock investors look for a firm fundamental base before buying a company. Value stocks typically have lower valuations and usually pay a dividend.
Pros and Cons of Value Stocks
Below are the pros and cons of value stocks:
Pro: Value stocks pay dividends
Because value stocks are often more established companies with predictable cash flows, they return some of their profits to shareholders in the form of dividends. Dividends can be a great source of consistent income, even if the stock itself is trading in a range.
Con: Value stocks have been lagging
Beating the returns of growth stocks can be tough in bull markets, but lately, value stocks have been underperforming regardless of the broader economic conditions. Right now, being a value stock investor requires patience and an immunity to fear of missing out.
Pro: Value stocks can carry less risk
Growth stocks tend to be more volatile, subject to the whims of the market, with higher risk for loss. Value stocks, however, tend to be less volatile, making them a less risky investment. While all stock investment bears some form of risk, value stocks may be the better option for more risk-averse investors.
Con: Identifying value stocks can be difficult
Identifying stocks with potential for long-term gain can be difficult. Accurately assessing a company’s value can be challenging, with no guarantees. Working with a knowledgeable advisor who understands how to read a company’s fundamentals such as its past and projected revenues, earnings, debt, and more can be helpful. Even so, this data does not point to any guarantees on a stock’s potential for long-term growth, and it doesn’t account for unexpected events like management changes, evolving markets, etc.
In our view, the growth stock vs. value stock debate is not an “either/or” proposition, but how much of each to include in one’s portfolio. Because of the attributes of each of these asset classes, we think a diversified portfolio for suitable investors should contain both. As financial advisors, we tweak the percentage of growth and value investments in our client’s portfolios based on current economic conditions, trends, and experience. While this approach certainly does not guarantee success or prevent loss, we’ve found it to be a solid way to invest our client’s hard-earned money.
We hope this article has helped you understand the difference between value and growth stocks so you can determine what’s right for you. If you have any questions, an experienced, truly independent financial advisor from Good Life Financial Advisors of NOVA can assist you. Contact us today!
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.