Any given investor may well prioritise either “growth” or “value” when constructing their portfolios. At the same time, analysts often classify individual stocks as either growth or value – what do they mean? To make things worse, the distinction is usually not that black and white and some stocks exhibit elements of both qualities. 

Even so, being able to tell the difference between these two categories is still a useful exercise – both to define your investing style and understand if your current portfolio aligns with your needs.

Some examples 

Before we dig into the characteristics of each style, let’s look at some classic examples of U.S. companies that fit into the growth or value moulds. These are not buy recommendations but only well-known companies that should give you an intuitive understanding of which kind of company fits into which style.

Whether an investor labels a stock as a “growth stock” or a “value stock” is a function of past earnings and stock price performance. 

Defining growth stocks

Growth investing is based on picking stocks that are growing fast, in the belief that they will keep growing, ideally even faster. The idea is that investors buy the stocks before the company’s earnings reach their peak, at which time it may be said to turn into a “value” company. 

As you can see in the table above, most growth stocks tend to be in the tech sector. These companies are not so much concerned with efficiently producing what they sell as finding new customers. In many cases, their value may be partly determined by products that are still in development. So, how do you identify growth stocks, financially speaking?

1. Rising sales. You need to confirm that there exists high demand for the company’s goods and/or services. In the modern era, user growth has surpassed sales as a more useful measure of growth, at least for technology companies. However, in most industries, sales is still the number one statistic. Young, fast-growing companies will typically reinvest profits to fuel future growth, meaning the company is less profitable than a mature one. 
2. High P/E. Growth investing does not rely on waiting for stocks to be undervalued – it typically means buying high and trying to sell higher. As mentioned above, earnings will be relatively low because they are being reinvested in growth, while investors are hoping to see rising sales and pay a premium for expected future growth. All together, this results in a high price: earnings (P/E) ratio
3. High volatility. One term often floated around is “priced to perfection”. If these companies disappoint the high expectations of their investors, the stocks can drop regardless of what the overall market is doing. On the flipside, the development of new products as well as announcements regarding M&A (Mergers And Acquisitions) make big upticks in the price more likely, too.

Defining value stocks

Value stocks are companies whose share price is low and whose earnings growth has perhaps been slow or even declining. Their market is near-saturated: the world is probably not going to buy much more soap, steel, or cell service than it does now. Some innovation still occurs in these stable industries, but nothing earth-shattering is expected.

Value investing is based on the logic that a good company can be underappreciated by the market and that its fortunes and valuation will soon improve. Some characteristics of value companies are:

1. Dividends. A value stock has typically seen its sales growth level off and will aim largely for consistency in its turnover. This consistency translates to its earnings, which allows the firm to pay out a regular dividend, giving shareholders an income without having to sell their shares.
2. Low P/E. These stocks are typically “undervalued”, meaning that investors are willing to pay less for each dollar the company makes. Oftentimes, these companies are quite profitable, but the growth in their profits is flat or low. Should profits start to rise again, the share price will move to reflect that.
3. Low volatility. Since investors tend to hold these stocks more for their dividends and are less sensitive to changes in the earnings of the company, the price tends to move little even when the immediate outlook for the company changes. 

Which one do investors prefer?

Individual investors generally follow either a value or a growth strategy. In general, though, neither is intrinsically “better”. There are periods of time when either growth or value will outperform the other. Typically, growth does well in a bull market and value holds its ground better in a bear market.

The following chart shows rolling three-year total return (including dividends) for the Russell 1000 Growth and Russell 1000 Value over three decades.

What about right now?

It’s true to say that recent times (since the ’08 financial crisis) have seen a long period in which growth investing was the more successful strategy. There have been only brief periods when value performed better (i.e. when the oscillator at the bottom of the chart falls below zero).

History suggests value is due to experience an even longer period of high performance at some point. However, the reason for value sometimes starting to perform better than growth in the last few years is generally held to be ultra-low interest rates. If rates should rise, though, this could prove to be a problem for the entire stock market. Concerns about a possible AI bubble – a growth-heavy situation if ever there was one – and geopolitical issues make it even harder to encourage investors to choose either the growth or value philosophy.

Conclusion

Whether to choose growth or value investing depends on the current market outlook and your own financial goals and risk tolerance. Both investing strategies offer both opportunity and risk. Which style you choose is ultimately a personal preference, informed by rational assessments of where the economy might be in five years’ time.