Value stocks and growth stocks are the names given to two types of company stocks on the basis of distinct investment methods and opportunities they drive in the market. The investors whose attention they call are typically named as value investors and growth investors.
Value investors look out for value stocks that observe a timely undervaluation in their prices due to economic and social factors but the entities to which they pertain have a better financial position in reality. Growth investors, on the contrary, invest in growth stocks that are anticipated to outperform similar other stocks on the market in long run.
Let’s explain both the said categories of company stocks in more detail and enlist some basic points of difference between the two.
Definitions and meanings
Value Stock
The term value stocks refers to those company stocks that are traded at a price lower than what the company’s fundamentals indicate otherwise. These fundamentals include the earning scale of a company, dividend payouts, clientele, sales, and the overall performance of a company.
Despite performing well, why do value stocks have an equity price lower than that of other companies in the same industry?
Most of the times, value stocks represent shares of well-established companies that are presently caught in a whirl of adverse events. For instance, frequent labor strikes, false accusations, legal problems, adverse publicity of principal officers, rumors’ impact on market, and similar other events may significantly push down the price of a company’s stocks.
Being traded at a lower price, value stocks create an appealing investment opportunity for value investors as they attempt to capitalize on market inefficiencies. A comprehensive view of the earnings, financial ratios, and stock valuation analytics help investors identify stocks that are presently undervalued but are likely to emerge back soon.
Example
CFT Ltd, a multinational trading company, has been operating for the last decade and has had a firm place in the stock market since the start. However, earlier in 2021, an executive director of the company was caught in a personal scandal of money laundering that pushed the stock prices significantly down from $10 per share to $5.7 per share. The average stock price within the belonging industry, however, was maintained at $10.2 per share.
Some financial ratios of CFT Ltd for the financial year 2021 in comparison to the industry averages are as follows:
| Key Financial Ratios | CFT Ltd. | Industry-average |
| Earnings per share | $2.5 | $2.63 |
| Debt to equity ratio | 0.27 | 0.25 |
| Dividend payout ratio | 33% | 30% |
| Price to book value ratio | 1.02 | 0.57 |
| Current ratio | 2.10 | 2.15 |
Together put, all the above ratios outline a level-headed financial performance by CFT Ltd. that is in line with the average industry trends. However, the share price of CFT has significantly fallen in contrast to the average share price level of the industry. The stocks of CFT tend to behave as value stocks presently.
Since the company’s financial indicators are still promising, the value-seekers would see the current position just as a temporary fall in equity price and consider the same as an ideal opportunity to enter the company. CFT’s present share price of $5.7 could be a fine value play for such investors because once the matter is settled and the public forgets about director’s scandal, the share price will hopefully begin to rise and reach to its deserving level.
Growth stocks
The term growth stocks refers to the shares of companies that are expected to grow at a rate significantly higher than that of the average growth in the market. Investors wouldn’t usually receive dividends on growth stocks for the reason that these companies follow a reinvestment protocol and would want to reinvest all or a major portion of their earnings back into the business to enhance their assets and revenues. Investors are generally inclined towards investing in growth stocks as they anticipate making handsome profits by the way of capital gains upon the future sale of these stocks.
What is so unique about growth stocks that lets them grow faster than other stocks?
Growth stocks would often be startups or small companies having unique product lines, newer technologies, innovative ideas, a better capital structure, and excellent management that put them ahead of the industry.
Example
BTC Ltd. is an automobile manufacturing concern that has newly stepped into the industry. The company is presently researching the manufacturing of electrically powered cars. As of now, the product is only in Phase I of ‘Research and Survey’ but once developed approved by the regulatory authorities, it can open new gateways of profits and capital appreciation for the company. The stocks of BTC Ltd. tend to act as growth stocks as automobile investors find a great potential of capital growth within them.
Difference between value stocks and growth stocks
Seven key points of difference between value stocks and growth stocks are as follows:
1. Meaning
Value stocks represent stocks that are being traded at a price lower than their actual worth and fundamentals. Such companies make higher profits, offer handsome dividends, and are expected to yield superior returns once their share prices catch up with their performance level.
Growth stocks represent companies that have high growth potential and are expected to outperform the market in long run through the appreciation in their stock prices.
2. Nature, size and age of the entity
Value stocks are likely to come from entities that are long-established, large and mature but are presently subject to an adverse situation. Negative publicity in respect of declining earning trends and legal snags are common indicators of value stocks.
On the other hand, growth stocks are likely to be startups that are innovatively driven. These may include companies from the fast-growing industries like biotech, technology, or fashion.
3. Current stock prices
Value stocks observe an undervaluation in their prices but have the potential to win higher prices in the long run. Hence, the value stocks are often bargain-priced as compared to other stocks in the market.
Growth stocks are likely to be precisely valued or sometimes, overvalued. The anticipation of their prices to grow at a higher rate than that of the market can often significantly pull the price of these stocks up. Growth stocks, therefore, observe higher pricing than value stocks.
4. Preference and financial goals of investor
Growth stocks may take longer time to establish and exhibit their full potential. Moreover, the companies with these stocks normally refrain to distribute dividend in early years of their formation rather they prefer to achieve a rapid growth rate through reinvestment of a large portion or whole of their profits in business assets and operations. Growth stocks are, therefore, a suitable strategy for investors who don’t need current income from their investment and can wait for a plenty of time before they get their money back.
The value stock entities, on the other hand, don’t see a significant room for growth and therefore tend to pay substantial cash dividend to remain attractive for investors. As mentioned earlier, these are usually old established companies and are characterized by attractive financial indicators. Once market reveals the real worth of these stocks, their share price can quickly recover from downfall. Value stocks, therefore, could be a more convenient approach for those investors who look for a regular stream of current income and want a more immediate payoff from their portfolio.
5. Risk and reward
Theoretically the value stocks are known to be less volatile and less risky for being associated with large established entities. These stocks pay dividends more frequently and therefore may be expected to bring some capital appreciation for investors even if they don’t meet or exceed the value that was predicted when they were purchased.
Growth stock companies, on the other hand, are usually not as active in paying dividends rather they retain most of their profit to plough back in business for accelerating their growth rate. Growth stocks observe high volatility on account of their extreme level of sensitivity to changes in entity’s future prospects. The probability of incurring loss in case of a these stock investments is relatively high, especially when the entity fails to achieve its growth expectations. For example, if a highly awaited product disappoints customers due to its improper functioning or design, the manufacturing company behind it may certainly face a plunge in its stock price. Growth stocks are generally considered potentially high rewarding but at the same time also known as high risk investments.
6. Identification matrices:
The following matrices might be helpful to identify the type of stock:
Value stocks:
- Low price to earnings (P/E) ratio
- Low price to book value ratio
- Regular dividends payouts
- Satisfactory current ratio
- Modest growth in revenues and profits
Growth stocks:
- High price to earnings (P/E) ratio
- High price to book value ratio
- Very low to no dividend distribution
- Rapidly growing revenues and profits
7. Price consideration while classifying the stock
The future price projection is the key element involved in classifying a stock as growth stock. Keeping in view their projected as well as historical growth rate, the price of these stocks is projected to be significantly higher than the current price over a period of few years.
While the value stocks also bear a good chance of price appreciation in future, they are primarily classified on the basis of their current price which is typically lower than their book value or at least lower than the value they deserve in the eyes of an expert stock analyst.
Conclusion:
Value and growth stocks both can be profitable investment opportunities for investors. The best approach for an individual investor highly depends on his investment style, financial goals and the risk level he is willing to face. Before following either of the two investment approaches, one must bear in mind that stocks face undervaluation and overvaluation in their prices for several reasons and not all of those reasons can be attributed to the underlying perception of growth and value stocks. In addition, many stocks become difficult to categorize on account of having both value and growth features.
Short-term investors, particularly with less market experience, must understand that stock performance often largely depends on the point or stage of the cycle at which the market is. For instance, value stocks are often expected to perform better in a bullish market whereas growth stocks, on the other hand, often exhibit a better performance in bearish market.
In long run, however, many investors opt for a mix of the two types of stocks. It allows them to gain value throughout the economic cycle in which the market trend is in line with either the value or the growth investment approach. Additionally, a right blend of value and growth stocks add diversity to investors’ portfolio and save them from heavy losses in case either of them underperforms.
