When it comes to investing in stocks for capital gains, there are two different approaches that can be taken in order to ensure that your stocks increase their worth: growth investing and value investing. (There are other rationales for investing, such as investing for dividends, but for now let’s stick with growth and value investing.) These two methods represent two different ways of viewing stocks and trying to profit from them. So, what sort of considerations do you have to make when considering which method to use when choosing your investments?
Investing Rationales
Growth Rationale – The growth investor is looking for companies that growing their business (which you probably guessed). These could be small, upstart companies that have a great deal of potential, or large companies that continue to expand into new areas and increase their business at a much faster rate than their rivals. If stock investing were horse racing (a reasonably apt metaphor), growth stocks would be those that are the reigning champions or the quickly rising upstarts. The growth investing model essentially involves trying to find some of the fastest expanding companies, and tethering your fortunes to their growth.
Horse Racing - An Ideal Stock Metaphor
Value Rationale – Value investing, on the other hand, focuses on finding stocks that have been knocked below the true value of their respective companies, then buying and waiting for the broader market to recognize their worth. As with growth investing, these companies can be either large or small, and the reasons they are currently undervalued can be diverse: bad news that took the stock prize below a reasonable level, a run of bad luck that decreased the company’s perceived value, or even a broader economic storm that dragged everything down at once (like we’ve just experienced). To go back to our horse racing metaphor, value stocks would be akin to the strong finisher who’s failed to win the past several races and wound up as the long shot.
Why Does This Matter?
The difference between growth and value might seem academic, and in a way, it is. There are those people who have argued that assigning stocks to the ‘growth’ or ‘value’ columns have nothing to do with the actual value of the companies, but instead such dividers display their own ignorance. (’Those people’ in this case include Warren Buffet, as you can see at the bottom of this linked page, so perhaps they have a point.) On the other hand, when looking at the performance of broad segments of the US economy, it appears that the value investing style has beat out the growth style in the past.
The results, if you are a mutual fund investor (particularly a passive indexer like me), is that your portfolio should attempt to lean more towards value and less towards growth in terms of your funds’ orientation. This does not mean that every value stock will outperform every growth stock; on the contrary, because the faster increase in value of growth stocks is sometimes deserved, the top performers in the growth category can and will outperform the best of the value classification. Rather, it means that taken as a whole, stocks that are categorized as value will outperform those in the growth column over time. Unless you fancy being a stock picker (and make a good job of it, as well), sticking to a portfolio that leans toward value stocks will lead to a much richer future for you and yours.
I hope you enjoyed this rather brief introduction to value and growth stocks, as well as the difference between the two. Good luck with your investing, whichever option you decide to choose.
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