Hi, can someone help me understand the major differences between stocks/funds labeled "growth" and those "value"?
Growth and value are two ways to classify investments, and both have benefits and risks. Generally speaking, the growth investment style seeks companies that are growing and whose earnings are expected to grow faster than the market. The value style focuses on stocks that are believed to be undervalued, and therefore have potential to produce long-term profits. Many advisors recommend including both styles in your portfolio to mitigate risk, as their respective performance typically moves in phases that react to changing economic conditions.
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Hi Melissa, in addition to the great answer from Andrew, here are some added generalities of growth versus value stocks. Growth stocks: 1) Typically grow earnings/revenues faster than the market. 2) Are less likely to pay dividends, prefer to reinvest cash back into the company. 3) Usually have higher Price/Earnings ratios and Price/Book ratios than average. Value stocks: 1) Generally said to be trading at a discount, undervalued. 2) More likely to be paying dividends and generating yield for an investor. 3) Relatively lower P/E and P/B ratios
If you are unsure about terminology or would like more details try visiting http://www.investopedia.com/. Good Luck!
Melissa, mutual fund managers, and almost all money managers have an investment objective.
Simply put, if a manager of a fund is seeking to invest in 'value' stocks, then he or she would be looking for stocks that are trading for less than what that manager believes it is currently worth; ie; a stock is trading for $15, and this particular manager feels it is worth $20.
A growth stock would be a stock from a company that is the potential to be worth more than it is trading for because the manager feels the business will grow; ie a company is about to unveil a new technology or is about to make acquisitions that will increase its bottom line, is is anticipated to grow organically.
It is very possible for any stock to be both a 'value' stock and a 'growth' stock.
Growth and value are different styles of investing. Growth stocks funds focus on companies that have revenue and earnings growth which are greater than the overall market. Value style funds focus on companies which are considered undervalued or trade at a lower valuation than the broader market. Hope this helps.
Melissa. Consider it this way. Two companies each make $1 million per year. One is growing quickly, and investors think it will soon double its sales. It reinvests all the money it makes to build plants and hire people so it can continue growing. Because investors think profits will be higher in the future, the stock may trade at a higher price. This is a growth stock.
The other company makes the same amount of money, but it is pretty stable. It's profits have grown only slowly for quite a few years. Since it isn't growing, it doesn't need to invest all its profits in plants and new hires, so it can return more of the profits to investors by paying dividends. Since the company isn't growing, this stock will likely sell at a lower price than the growth stock - even though their profits are the same today. This is a value stock.
Over time, actually, value stocks have somewhat outperformed growth stocks - but only slightly. It is generally a good idea for investors to diversify and own some of each style.
You have received a good theoretical overview from the other advisor posts. But you may want to understand more specifically how a stock is classified as a value, growth or core. There are many investment services that slice and dice the stock market into smaller sections of the overall market. You have probably heard of companies such as S&P, Russell and Morningstar. Each company, and many others, provide a service where they will classify every stock in a market (say all US Stocks or all European Stocks) into large, mid, small and value, core, growth (core is in between value and growth).
Each company has their own mythology for how they break each stock into its category but in general for value, core, growth they are looking at valuation metrics. The most common are price to earnings, price to book, price to cash flow and price to sales. The stocks which have the lowest price to earnings/book/cash flow/sales will be classified as value stocks. The ones with the highest will be growth and the ones in the middle are core. A stock can move from one category to another over time as their price scores increase or decrease.
As an example say stock A is priced at $10 per share and it earns $1 and it has a book value of $5. It has a price to earnings ratio of 10 to 1 and a price to book value of 2 to 1. If stock B has a price of $10 a share but it only earns 50 cents and has a book value of only $2 it will have ratios of 20 to 1 P/E and 5 to 1 P/B. If these were our only 2 stocks we would classify stock A as a value stock and the stock B as a growth stock since stock A has a lower P/E and P/B ratios then stock B.
Morningstar has classified the entire US Stock market into value, core and growth and currently the average ratio for various metrics for each category are as follows:
Value Core Growth
Price/Earnings 14.11 17.87 24.23 Price/Book 1.70 2.68 4.32 Price/Cash Flow 7.43 12.43 15.13 Price/Sales 1.06 2.02 1.06
Hope this helps.