For years investors have debated whether to favor value or growth stocks. Let’s take a closer look at this debate.
What are growth stocks? Very simply, they are the stocks of companies that have historically grown faster than average and are expected to continue doing so. Typically, growth is measured in terms of revenue, profits, or other factors. Due to stronger anticipated growth, investors are willing to pay more for growth than for value stocks relative to current earnings. NOTE – growth stocks typically pay lower or no dividends.
Despite the attractiveness of growth, these stocks carry certain risks. For example, future growth may not play out as expected due to problems with the economy, a particular industry, or the company itself. In addition, price-to-earnings ratios may decline unexpectedly.
What are value stocks? These are the stocks of companies that experience historically slower growth in terms of sales and earnings; however, that slower growth might be more consistent over time. In addition, a value company can be defined as one that recently experienced some type of problem that presents a turn-around opportunity.
In contrast to growth stocks, value stocks typically offer higher dividend yields. To learn more about the benefits of dividends, please refer to our April 12th Wealth Matters Blog.
Value stocks also present certain risks. An evaluation of a company as a “good value” may be misread…and…it can be very difficult to adhere to a value discipline when prices are beaten down.
Which type offers the greatest returns? As so often is the case, the answer is “that depends”. As a general comment, the average annual return for value stocks as a category exceeded its growth counterpart between 1970 and 2010.
Remember – a well-designed stock portfolio has exposure to both!