The terms “Growth stock” and “Value stock” both have ambiguity associated with them related to their mutual difference as per the view of investors. The key difference lies mainly in the manner they are perceived by the market, by stock analysts and particularly, the investor regardless of how they are bought and sold. Gerald Dewes
Growth stocks are associated with successful companies whose earnings are expected to outperform the rest of the market overall or one of its sub segment for a period of time. They can be found in small, mid or large market capital sectors and generally have high price-to-earnings (P/E) ratios and high price-to-book ratios.
P/E ratio is computed as the market value per share divided by the current year’s EPS (Earnings per share). For instance, if a stock is currently trading at $64 per share and its earnings over the last 12 months have been $2 per share, its P/E ratio is 32. The price-to-book (P/B) ratio is a comparison between company’s current market price and its book value. It’s calculated as stock market price divided by book value per share.
Investors purchasing growth stocks generally receive returns by trading them in open market. In other words, through future capital appreciation (the difference between the amount paid for a stock and its current value), rather than by enjoying dividends. Historically, it has been more common for growth companies to reinvest retained earnings in capital projects but sometimes growth stock shareholders are also paid dividends. Recently, because of changes made in tax laws resulting in lower tax rate on corporate dividends, growth companies have been offering dividends more often than before.
Value Stocks are associated with well-established companies that are trading below the analysts assessed price of that stock. They are traded at a price lower as compared to their fundamentals such as dividends, earnings, and sales. They generally have low current price-to-earnings ratios and low price-to-book ratios. Their prices are below the stocks’ historic levels or may be associated with new companies that aren’t recognized by investors. Stocks can be undervalued for various reasons such as public perception, company’s involvement in illegal activities, company’s significant figure accused of personal scandal or any other reasons.
Investors choose value stocks to make an investment in the hope that they will increase in value when the broader market recognizes their full potential, which should result in rising share prices. Thus, investors’ potential profit margin will increase much more as compared to investments made in higher-priced stocks that increase modestly in value.
At the end, investment in growth and value stocks are styles of investing. Neither approach is guaranteed to provide market value appreciation of stock. Both carry investment risk but differently, for example growth stocks are more volatile as compared to value stocks, which are relatively safer to invest in. Always remember before making any sort of investment decision that any stock’s rate of return and principal value fluctuate with changes in market conditions. Shares, when sold, may be worth more or less than the price they were purchased upon.
The decision to make an investment in either one of those also depends upon individual’s personal risk tolerance, investment goals and time horizon. Regardless of your personal assessment in the factors mentioned before, both types of stocks may have a place in investment portfolio.
The information in this newsletter is not intended as tax, legal, investment, or retirement advice or recommendations, and it may not be relied on for the purpose of avoiding any federal tax penalties. You are encouraged to seek advice from an independent tax or legal professional. The content is derived from sources believed to be accurate. Neither the information presented nor any opinion expressed constitutes a solicitation for the purchase or sale of any security.
Gerald R. Dewes does not provide investment, tax, or legal advice. The information presented here is not specific to any individual’s personal circumstances.
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