Value vs growth stock! Almost every investor comes across this choice once in a while. Many argue on the superiority of one investment strategy over the other. However, both investment options have their pros and cons. Furthermore, the choice for the best strategy depends on various factors in the investor’s horizon. These include volatility, risk, endurance, and time horizon, to name a few. As an investor, you should consider various points pertaining to both the investment options and then carefully select the best strategy. In this post, we’ll help you in making a wise choice. We’ve compared the two strategies so that you can understand both, differentiate between them, and select the most ideal option based on your needs. So, let’s get started!
Growth stocks and value stocks
Before heading to the comparison between value and growth stocks, let’s understand the basics:
What are Value Stocks?
Value stocks, in general, are the undervalued stocks. These refer to those stocks that trade at a value lower than their actual worth thereby yielding high returns. Thus, these types of stocks are quite appealing to investors looking for high ROI.
Ways to identify a value stock
Value stock is a good investment option if one wants to earn huge profits. Individuals invest in the shares that are available at cheap values or at a discount. But, how will you find whether the stocks are available at a low price? For that, you’ll have to identify stock’s intrinsic value and then compare it with the stock’s current value.
Intrinsic value includes cash flows, profits, financial structure, fundamental factors (brand and market structure), and revenues. All the necessary elements of the company must be considered while purchasing the value stock. There are many other factors which help to determine the stock’s value:
P/B Ratio (Price-to-book Ratio)
In a company, the P/B ratio is the ratio of the stock price and the share’s book value. Generally, the book value is the result of subtracting the company’s entire assets with the liabilities. If the ratio is low, the stock is undervalued and can be purchased.
P/S Ratio (Price-to-sales Ratio)
When the company divides its market capitalization with its total revenue, it is called the P/S ratio. Market capitalization is the product of the company’s outstanding shares and the price per share of the shares. If the calculated P/S ratio is low, then the stock is undervalued and ready to be purchased.
What are Growth Stocks?
A growth stock refers to those stocks that have huge future potential so they outperform the overall market. Growth stocks can generate a substantial cash flow of the company and guarantee an increase in the company’s profits and revenues in the future.
Ways to Identify the Growth Stock
It is quite challenging to determine the growth stocks in a company as it requires interpretation and correct judgment. So, let’s have a look at some crucial indicators which will help in interpreting the growth stocks.
Earnings per share is the ratio of the net profit after tax and the total outstanding shares. Hence, it has a direct relation with the company’s stock price, i.e., if the company’s EPS rises, the stock market witnesses a hike. A regular record of the company’s EPS in the past few years should be maintained. It helps in determining the company’s performance and the growth stocks.
Debt to Equity Ratio
Maintaining debt is quite beneficial for a company as it determines the company’s expansion plan. It further helps in calculating the Debt to Equity Ratio. If the company has a healthy debt to equity ratio, it can give a complete picture of the company’s growth and health.
Various companies have a high growth rate. These growth rates determine the company’s competitive edge over competitors. Different ways that help to determine the company’s competitive advantage are:
- Low-priced products – Offering low-cost products as compared to rivals can be beneficial for your company’s growth. Factors like cheap materials, efficient types of machinery, dynamic distribution networks,etc., can facilitate in setting low product cost.
- Better service quality – To gain a competitive edge, you should work on your after-sale services. If you provide customer-friendly and enhanced sales service, your company can gain a higher competitive edge.
Which is Better – Value vs. Growth Stocks
While surfing a company, an investor can find both value and growth stocks. However, these stocks are equally beneficial for the investor and company, but for different durations. It can lead to immense confusion in the mind of an investor to decide the best investment method. To reduce further searching, we’ve listed some essential differences between the two:
Pricing of the Stocks
Though value stocks are underrated, they can offer higher returns later in the future. It is the reason why they are priced low as compared to other shares of the company. When an investor invests in value stocks, it is referred to as value investing. Basically, value investing refers to investing in shares now to generate higher revenues in the future.
On the other hand, growth stocks bear the correct value, and sometimes, they are overvalued. Their prices generally increase as the growth rate of the stock increases. However, investing the amount in growth stocks is termed as growth investing. Those investors that look at the continuous growth rate should choose growth stock.
Dividends and Business Profile
There are various companies which face depression due to different reasons, and so their stocks get undervalued. However, their stock’s value increases over time as the company gains profits. These stocks are valued stocks. In valued stocks, the company is liable to pay dividends. Further, it doesn’t re-invest the entire retained earning amount again in the company.
As growing companies mostly offer growth stocks, they generally bring something innovative in the market regularly. It helps the company to grow further and gives it a competitive edge. In terms of dividends, the growth stocks may offer a minimum or, at times, no dividend at all. The company usually does this as it is a mandatory reinvestment procedure of the retained earnings.
Risk and Investment Metric Ratios (IMR)
Most of the time, valued stocks remain undervalued. Due to this, their investment metric ratio is low. However, the metric rate is likely to increase only when the market corrects the stock’s price. Till then, the stock’s price remains low, and the investors also risk losing their money. Thus, it is highly risky to invest in value stocks.
On the other hand, growth stocks have a correct market value. So their metric ratio is quite high, which generally includes P/E ratio, EPS, and P/B ratio. As their price generally increases with time, they offer less or no risk to the investors. Hence the investors aren’t easily affected by adverse business environments in case of growth stocks.
So, this was a comparison between the two stocks. Both investment options cater to different needs. Hence, the selection of the most suitable investment strategy purely depends on your investment needs and your horizon.