Value vs. Growth in Investing: What’s the Difference?

In investing, the terms value and growth both refer to two different categories of stocks, as well as the two investing styles built on their divergence. While value investors look for stocks they believe are undervalued by the market, growth investors seek stocks that they think will deliver better-than-average returns.

Value and growth are sometimes seen as an either/or option, but portfolios have room for both strategies. Finding the right blend of value stocks and growth stocks can lead to increased diversification.

Good Prospects + Good Planning = Value

Value investors hunt through the market for hidden gems: stocks with low prices but promising prospects. Analysts define value investments as stocks whose prices do not necessarily reflect their worth.

These value stocks are usually those of larger, more well-established companies that are trading below the price that analysts, depending on the financial ratio or benchmark used for comparison, feel the stock is worth.

Another way to analyze these stocks is by comparing a company’s intrinsic value to its current market value. A firm’s intrinsic value is determined by evaluating the company’s fundamentals, including its business model, management, financial statements, and competitive situation. When a company’s intrinsic value is higher than its current market value, the stock is considered a value investment.

The reasons these stocks may be undervalued can vary widely, including a short-term event such as a public relations crisis or a long-term phenomenon such as depressed conditions within a particular industry.

Value stocks do not have the flashy characteristics of growth stocks. Companies considered value investments tend to have steady, predictable business models that generate modest gains in revenue and earnings over time.

Value investors buy stocks they believe are underpriced, either within a specific industry or in the broader market, betting the price will rebound once other investors catch on.

Generally, these stocks have low price-to-earnings ratios (a metric for valuing a company) and high dividend yields (the ratio a company pays in dividends relative to its share price).

The risk? The price may not appreciate as expected.

Good Products + Good Management = Growth

Analysts believe growth stocks have the potential to outperform either the overall markets or a specific subsegment. Growth stocks can be found in all capitalization sectors (small, mid, and large) and can only retain growth status while analysts feel that they have not yet achieved their potential.

Growth companies are those considered to have a good chance for considerable expansion over a few years, either because they have products that are expected to sell well or because they appear to be run better than many of their competitors, leading to a predicted edge in their market.

Growth investing is essentially doubling down: Investors bet that a stock that has already demonstrated better-than-average growth (via earnings, revenue, or some other metric) will continue to gain, making it attractive for investment. These companies typically are leaders in their respective industries; their stocks have above-average price-to-earnings ratios and may pay low (or no) dividends. However, by buying at an already high price, investors run the risk that something unforeseen could cause the stock’s price to fall.

Which Style Is Best?

Stocks go through bull-market cycles of varying length that favor either growth strategies, value strategies, or both; a bear market, of course, favors neither.

The stocks in the Russell 1000 Growth Index outperformed those in the Russell 1000 Value Index during the 2009-20 bull market, for example, but that is not the case on a year-by-year basis. Value outpaced growth in 2016.

These styles often come down to a specific industry. Currently, more than a third of stocks in the S&P 500 Pure Growth Index are in the information technology sector, while about a third of stocks in the S&P 500 Pure Value Index are in the financial sector. This breakdown makes sense: The country’s major financial institutions are far more established than the relatively new leaders in information technology.

Value investors look for companies that have already earned their stripes and have a stock price that is lower than it should be (and may rise again to reflect that).

Growth investors look for companies with future potential and expect the stock price to increase (even if it is already relatively high) as the companies reach or exceed that potential. The desired destination is the same, but with different ways of getting there.

Value stocks are theoretically considered to have a lower level of risk and volatility because they are usually found among larger, more established companies. And even if they do not return to the target price that analysts or the investor predict, they may still offer some capital growth. These stocks often pay dividends as well.

Growth stocks, meanwhile, will usually refrain from paying out dividends and will instead reinvest retained earnings back into the company to expand. Growth stocks’ probability of loss for investors can also be greater, particularly if the company is unable to keep up with growth expectations. For example, a company with a highly touted new product may indeed see its stock price plummet if the product is flawed. Growth stocks, in general, possess the higher potential reward, as well as risk, for investors.

You may also opt for “blended” funds, which are created by portfolio managers that invest in both growth stocks and value stocks. Many managers of these blended funds pursue a strategy known as “growth at a reasonable price,” focusing on growth companies, but with a keen awareness of traditional value indicators.

The decision to invest in growth vs. value stocks is ultimately left to an individual investor’s preference, personal risk tolerance, investment goals, and time horizon. Over shorter periods, the performance of either growth or value stocks will also depend in large part upon the point in the cycle that the market happens to be in.