Stock investors often hear about growth stocks and value stocks. The two styles take different approaches to picking companies, and leadership between them tends to rotate over time. Understanding the difference can help you build a portfolio that holds up in different kinds of markets.
What are growth stocks?
Growth stocks are shares of companies whose earnings have grown faster than average and are expected to keep doing so. Typical characteristics include:
- Higher prices relative to earnings. Investors are willing to pay a premium today because they expect the company’s profits to keep rising.
- Strong earnings growth. These companies may be able to grow in different economic environments, often by reinvesting profits rather than paying dividends.
- More volatility. Because so much of the price depends on future expectations, a disappointing earnings report or negative news can send the stock down sharply.
What are value stocks?
Value stocks are shares of companies that appear inexpensive relative to their earnings, assets, or dividends, often because they have fallen out of favor. Typical characteristics include:
- Lower prices relative to fundamentals. The idea is that good companies will eventually be recognized, and their prices will recover.
- Priced below similar companies. Value stocks are often created when investors overreact to short-term problems such as disappointing earnings, bad publicity, or legal issues.
- Often less volatile, but not without risk. A turnaround can take a long time, and some cheap stocks stay cheap for good reason.
Growth, value, or both?
Neither style has been the permanent winner. Historically, growth stocks have tended to do better when interest rates are falling and earnings are rising, and they can be the first to fall when the economy cools or rates rise. Value stocks, often in more economically sensitive industries, have tended to do well early in a recovery but can lag during a long bull market. There have been long stretches when each style led, followed by periods when the other took over.
Because nobody can reliably predict when leadership will change, a balanced approach that owns both growth and value stocks, or funds that hold them, may be most appropriate for long-term investors. It can help smooth returns over time and keep you from making a large bet on one style at the wrong moment. For more on staying disciplined when one part of the market is outperforming, see Thinking of Timing the Market?.
Investing in stocks and mutual funds involves risk, including the possible loss of principal. Talk with your financial professional about how growth and value fit your portfolio.
Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual.
