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In the investing world, there are two dueling schools of thought: growth and value.
There is no business school definition for either type of investing style. But broadly speaking, growth tends to prioritize high-potential stocks — even at a premium. Value, on the other hand, focuses on undervalued stocks with steady potential.
Knowing the difference between growth and value investing can be enormously helpful when building a portfolio.
Growth stocks generally come with greater expectations for future growth. For investors, that measuring stick could be future profits or future earnings, figures that Wall Street analysts often estimate themselves.
High growth companies are often associated with early-stage or younger companies, which may also come with little to no dividend payout because of their lack of reliable cash flow.
The attraction of future success may also make growth stocks more expensive stocks to buy. But growth investing emphasizes that paying a pretty penny is the price of admission for solid gains in the future.
Value stocks, in comparison, come with more muted expectations for future growth.
Instead, the focus is on finding “undervalued” stocks that have solid balance sheets and financials but lack the expectations for breakneck growth in the future. As such, these stocks may go unloved by investors but could be available for cheaper prices.
Value stocks are often associated with established companies with a history of steady cash flow that allows them to pay out dividends, making them less risky investments.
What makes a growth stock expensive and a value stock cheap?
There are many types of measurements for the relative price of a security but an oft-cited figure is the price-to-book ratio. The P/B ratio, sometimes P/BV ratio, compares a stock’s price to the company’s net assets (total assets minus liabilities) on its balance sheet.
The higher the P/B ratio, the more expensive the company is relative to the value of the assets it currently has on its “books.”
Within the context of growth and value investing, a growth-minded portfolio may be willing to pay for expensive stocks with high P/B ratios on the promise of greater future returns. A value-minded portfolio prefers cheaper, undervalued stocks with low P/B ratios for stability and less risk.
Growth or value?
As with everything, the “better” investing strategy depends on your investment horizon and other factors —like available capital.
But over the course of 2020, growth stocks have dramatically outperformed value stocks, even in the midst of a global pandemic.
Two iShares ETFs breakout the Russell 1000 (a collection of 1000 large- and mid-sized companies) into the two buckets of growth and value.
The iShares Russell 1000 Growth ETF (IWF), most weighted toward tech companies, logged substantially higher gains than the broader market during 2020. The iShares Russell 1000 Value ETF (IWD), most weighted toward financials, underperformed the market for comparison.
But Goldman Sachs wrote November 11 that there are cyclical factors that can at some point swing favorably for value stocks.
“History shows that environments of strong and accelerating economic growth typically support Value stock outperformance in terms of both magnitude and hit rate,” Goldman’s portfolio strategy research team wrote.
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