Growth Vs. Value Stock Investing: A Beginner’s Guide

Wall Street has proven to be a great long-term wealth-building vehicle. The S&P 500, for example, has rewarded patient investors with an annual average return of 13.6% in the past 10 years. However, it is worth noting that not all stocks that helped investors beat the market in that time are created equal. Many of the most desirable stocks may look the same on their surface, but a closer look at their fundamentals will reveal most equities fall under two categories: growth and value stocks. These equities have demonstrated an increased propensity for creating wealth over time, which begs the question: Which types of stocks are better for today’s investors? More importantly, who wins the ongoing growth vs. value stocks debate? The following will discuss value vs. growth investing and which strategy may be suited for your specific goals.

What Are Growth Stocks?

As their names suggest, growth stocks represent companies whose prerogative is to grow at a fast pace. By that definition, however, every company listed on the stock market could conceivably adopt the growth stock moniker. Fortunately, there are more specific indicators to help us differentiate growth stocks from undervalued stocks.

Growth stocks are traditionally smaller companies with aspirations of becoming leaders in their respective industries. In doing so, growth stocks tend to trade immediate profits for accumulating revenue. More specifically, growth companies prioritize generating the most income possible over retaining profits on their balance sheets. That means most growth companies are perfectly comfortable putting money back into the business to expand operations.

In the short term, the vast majority of growth stocks aren’t even profitable because of their willingness to fund future expansion. It isn’t until the businesses mature enough to turn their previous investments into actual profits that they start to shed the idea that they are still growing. Consequently, once growth stocks turn their attention towards maximizing profits, they may no longer prioritize growth; they may be more content maintaining the status quo, which leads directly into the growth vs. value stocks debate everyone is interested in settling.

Understanding Growth Investing

Investors covet true growth stocks with long-term strategies. If for nothing else, building a position in a growth stock while it’s still in its growth phase has the potential to create immense wealth, given that the company has years to reinvest revenue into a promising business model.

Growth stocks tend to trade at higher multiples than their less promising competitors. The untapped potential of a promising growth stock increases its perceived value in the eyes of growth-minded investors, which ultimately leads to more buying and stock price increases. As a result, great stocks often get caught in a positive feedback loop. Investor sentiment will oftentimes increase the stock’s price-to-earnings (P/E) ratio, which suggests the company’s growth rate will outpace the broader market.

The said, not all growth stocks live up to their potential. In fact, only a small minority of stocks will actually outpace the growth trends set by the overall market. Therefore, it is important to understand growth investing to pick the right stocks. Investors can’t simply evaluate a growth stock based on its P/E ratio; some don’t even have earnings. Instead, investors need to account for every metric, some of which are objective and others that are subjective.

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