Growth Stocks
Growth stocks are associated with high-quality, successful companies whose earnings are expected to grow at an above-average rate relative to the market. Growth stocks generally have high price-to-earnings (P/E) ratios and high price-to-book ratios. The P/E ratio is the market value divided by the current year’s earnings per share. For example, if the stock is trading at Rs 500 per share and its earnings over the last 12 months have been Rs 25 per share, its P/E ratio is 20.
Share market often places a high value on growth stocks. Therefore, investors value these stocks more and are usually willing to pay more.
Investors who purchase growth stocks receive returns in the form of capital gain. A capital gain is an increase in price over the purchase price of a stock. Such investors do not look for dividends. Although dividends are sometimes paid to shareholders of growth stocks, it has been more common for growth companies to reinvest earnings in capital projects. Due to reinvestment, companies can make more profit, increasing the market value of shares. Market places high value on such companies as they show the potential for earnings growth.
Value Stocks
At times, growth stocks may be seen as expensive and overvalued, which is why some investors may prefer value stocks that are considered undervalued by the market. Value stocks tend to trade at a lower price relative to their fundamentals (including dividends, earnings, and sales).
Value stocks generally have good fundamentals, but they might have fallen out of favor in the market and are currently priced lesser than their actual price. They may sell at prices below the stocks’ historic levels or be associated with new companies that investors have not entirely recognized.
Value stocks generally have low current price-to-earnings ratios and low price-to-book ratios. Investors buy these stocks 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 hope that if they buy these stocks at current prices and the stocks eventually increase in value, they could make more money than if they had invested in higher-priced stocks.
Growth Vs. value Stocks
Growth and value are styles of investing in stocks. None of these investment styles guarantee a gain in a stock’s market value. Both carry investment risk. Since the market value of stocks fluctuates with changes in market conditions, their returns also vary. Shares, when sold, may be worth more or less than their original cost. Investments that provide higher rates of return also involve a greater degree of risk.
Growth and value investments tend to run in cycles. Understanding their differences may help decide which approach is appropriate to achieve investment goals.
Regardless of which type of investor you are, there may be a place for both growth and value stocks in your portfolio. This strategy may help you manage risk and potentially enhance investment returns over time.
