Value Stocks vs. Growth Stocks: Which One is Right for You?
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Every investment is driven towards the enhancement of wealth. When it comes to stocks, investors either buy stocks in the anticipation of making profits by selling the stock when its price increases or by earning dividends paid by the company as investment income. Investors who have knowledge of the types of stocks, namely growth and value, are capable of enhancing the worth of their portfolios.
Here’s what you need to know about the two types of stocks and which one is the most optimal for you.
Growth Stocks vs. Value Stocks
Growth stocks and value stocks can be differentiated from each other on several grounds. These factors are as follows:
Growth stocks, as the name suggests, possess substantial capability to demonstrate better performance than the overall market over a period of time. Value stocks, on the other hand, trade at a price lower than their actual worth, thereby offering higher returns.
2. Stock Prices
Growth stock prices are relatively high in comparison to their sales/profits because investors expect higher sales/profits in the future. Meanwhile, value stocks entail relatively low prices.
3. Earning Methodology
Growth companies can belong to small, medium, or large capital industries. There are two reasons due to which a growth stock is anticipated to have a considerable potential for expansion in the foreseeable future:
- The first is that the company possesses a product or a product range, which is likely to hit high sales.
- Secondly, the company is being more efficiently operated compared to others in the market, thereby gaining a competitive edge.Value companies are normally large and successful organizations, whose stock prices have gone down due to reasons such as a scandal being uncovered, or the company being involved in unprincipled practices. However, with strong financial ratios of the business, investors take this opportunity to purchase stock in the anticipation of an increase in the price once the scandals are forgotten.
4. Return on Investment
In the case of growth stocks, investors earn profits by selling stocks at the right time. Growth companies do not pay out dividends as they keep re-investing their funds in innovations, expansions, acquisitions, workforce enhancements, purchase of machinery and equipment, etc. Investors have to remain cautious and aware of stock prices so that they can ascertain when to sell the stock to make maximum profits. Meanwhile, value stockholders earn a more steady income on investment in the form of dividend payout by the companies.
5. Risk Tolerance
Investment in growth stocks involves a higher risk level because the returns are completely based on the future expectations of a high growth rate. Stock price fluctuations are higher and there is no assurance that the growth strategy of the company will materialize profitably. Meanwhile, value stocks entail lower risk since the company involved is larger and well-established. Sooner or later, the stock price will reach its optimum level when the actual value of the company is recognized across the market.
6. Time Horizon
Growth stocks need a larger time span for return on investment since growth tactics and processes require time to materialize and obtain positive outcomes. On the other hand, a smaller time span is required to gain returns from investment in value stocks, as the company typically pays dividends annually.
Which one is right for you?
The biggest question of which investment approach is better for you depends upon several factors associated with your perceptions and also past performances of the stocks. These factors are:
1. Level of Risk
How much risk are you prepared to endure? This is a major factor in deciding whether you should opt for growth stocks or value stocks. If you can absorb higher risk then growth stock is a feasible approach as it involves higher returns but is based on future expectations. However, if you are looking for a safer option, then value stock could be a better choice since it has guaranteed returns in the form of dividends.
2. Investment Goals
What is it that you want out of your investment? Are you looking for low but assured returns or higher returns with an uncertainty factor involved? If a lower rate of return is acceptable to you, then you can settle for value stocks. However, if you are seeking higher return rates then opting for growth stocks can be more beneficial.
3. Acceptable Time Period for Return
Another extremely important factor that governs the investment decision is the time span that you are willing to wait for returns to start coming in. If you can wait for a longer span of time, then growth stocks are a good option. However, if you want faster returns, you can invest in value stocks.
While making the most of your investment decisions, you tend to look at past performances of the financial instrument. However, in the case of growth stocks and value stocks, past performances are very reliable indicators of future performance. In case of growth stocks, you might want to select companies that have exhibited efficient cost control and sustainable competitive advantage to ensure accelerated growth in revenue, along with a competent management team. When it comes to value stocks, it is better to rely on the financial ratios of the company to determine its profitability in the future. To ascertain the financial health of a company, several financial ratios like debt-equity ratio, price-earnings ratio (P/E), price to earnings growth ratio (PEG), etc. must be analyzed. Moreover, the company’s book value must be calculated, which in turn should be divided by total outstanding shares to arrive at the book-value-per-share ratio. A comparison must then be drawn between the ratios of various companies operating in the same sector.
To sum it up
You can pick the most suitable stock for your portfolio by analyzing the above-given factors. Most investors opt for a portfolio that has both growth stocks and value stocks. Value stocks ensure that you receive guaranteed investment income over the short-term, while growth stocks ensure that you have a higher rate of returns in the long run. The financial ratios and factors that need to be calculated and analyzed before taking a decision require expertise.
To make sure that your investment portfolio is optimized, you should take the first step towards appointing credited and acclaimed financial advisors. They can help you enhance your knowledge and understand the various aspects of financial planning so that you can make the right decisions.