Growth stocks or value stocks, which one should I buy?
One of the highly recommended ways for one to begin their investing journey is to follow goal-based investing. This means that you are setting some pre-determined objectives before investing in an instrument, and not just investing randomly, but investing to generate a retirement corpus which is a long-term goal, or investing to buy a vehicle or a house. Most of our goals require a long-term investment horizon and equity commands the lion's share in the asset allocation for these goals. As a subset of equity investing, there exist 2 investing styles, namely growth investing and value investing, and in this article, we will understand more about what one should invest in, growth stocks or value stocks?
Let’s begin by defining growth stocks and value stocks and how an investor should go about identifying these.
Growth stocks are those stocks which are expected to show growth at a rate faster than the industry average and their respective competitors. So, it is highly likely for growth stocks to witness a sharp rise in their prices within a short time.
Generally, these stocks don’t have a long and prominent operating history as these companies may be comparatively new players in the market, but the potential which they have for growth tends to beat other stocks. The reason for this can be attributed to multiple factors, like the fact that the company is operating in a newly minted industry which is growing at a rapid rate, or the fact that the company has certain technology, products or professional expertise in delivering top-of-the-line goods and services, giving it a considerable edge over its peer group. Since such companies are relatively new, it is very unlikely for them to give out dividends, as they tend to reinvest all the profits back into their business for the purpose of expansion.
Also Read: Growth Stocks: Their Features And Benefits
On the other hand, value stocks are those that are currently undervalued in the market. The key word here is undervalued, because of the fact that these companies are fundamentally strong, and their stock has inherent value, also known as Intrinsic value, which hasn’t been realized by the market yet. And when the market does understand the inherent value which this stock carries, the market price of the stock will catch up with its inherent value, thereby generating substantial returns for investors.
The companies attributed with value stocks are fittingly those who are trading at lower price levels may be due to the market cycle not being in favour or due to general economic trends and consumer behaviour or recent bad result. But please understand the difference between value stocks and poor stocks.
Poor stocks don't have growth prospects and fall in their prices are unlikely to recover. Most of the time, the fall in the stock prices is due to some financial frauds, false narratives, poor execution, etc., and specific to that company only. On the other hand, value stocks can recover when things move in their favour and fall in their price is temporary.
How to discover growth stocks and value stocks?
Some of the ways to identify Growth stocks are a high Price to earnings ratio and high growth rate. These stocks have low dividend payout and expected to have above average performance in the future.
When it comes to identifying value stocks, one can calculate the Intrinsic value of a stock through various methods like discounted cash flow model, relative value methods, etc. If after this analysis it is found that the current value of this company in the market is lesser than its intrinsic value, owing to its strong fundamentals, you may have a possible value stock on your hands.
A point to keep in mind here would be that value investing comprises of hunting and investing in stocks which are available at a discount as compared to their intrinsic value and growth investing involves selecting those companies having an above average growth potential.
Pros and cons of each of these approaches
Starting with the pros of value investing, investors have the chance to earn solid profits generally over a long timeframe in a relatively low-risk high-reward scenario while being able to utilize the compounding effect to its fullest. Some cons of value investing can be the effort which is usually required to identify fundamentally strong and intrinsically valuable companies from the rest of the lot. The fact that it requires a lot of patience on the part of investors before they start seeing substantial returns may also be a turn-off for certain investors who wish to get rather quick gains.
Let’s now come to the pros of growth investing. An investor usually needs only a single investment in a very promising growth stock that can generate substantial returns and if everything goes right for that stock, they can get much better returns than the market.
And as a major con, growth stocks are associated with comparatively higher volatility and consequently come with higher risks. On top of this, growth stocks can be perceived as particularly overpriced and rarely come cheap. And there is the ever-looming risk of the company not living up to the promises it made, so there’s a lot to consider before making any investment decisions.
We can say that an optimal way to move ahead would be to diversify one’s portfolio within both these kinds of stocks So how should one move forward with this newfound knowledge? The first step should be to have a look at one’s finances and review the allocations, and then take a bird’s eye view of one’s goals and risk appetite. The next step would be to find out what amount one is willing to invest. And after this, one can use the methodologies discussed to carry out their own assessments in identifying suitable growth and value stocks. One can also have a portfolio consisting of only growth stocks or only value stocks.
All in all, one should preferably follow a particular investment approach after a thorough examination of one’s risk profile and investment objectives.
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