When you buy equities, or shares in a company, these can usually be classified as either value or growth oriented.
Sometimes it can be difficult to tell the difference. However, there are a few key characteristics that differentiate the two, which makes it easier once you know what you’re looking for.
Even more importantly, why should you invest in value stocks and what are the alternatives?
What is Value Investing?
Put simply, a share could be classed as value oriented if the price is on the lower side relative to the long-term potential of the company.
The stock market is fickle and the price of a share can rise and fall daily depending on trends and market sentiment. Value investors look beyond this and will consider a company’s earning potential and long-term fundamentals. The goal is to buy shares that the stockmarket is underestimating.
Value stocks usually include well-established companies with healthy profits, no problematic debt, and good cashflow. However, to be considered a value play, the shares must be undervalued as this offers the greatest potential for long-term returns. Assessing this requires good analytical skills – Warren Buffett is perhaps the financial world’s best known value investor.
What is Growth Investing?
Growth companies usually thrive on the back of market trends and may grow very quickly in a short space of time. Dividends are normally reinvested to allow the company to boost growth further.
Growth companies are often reliant on borrowing or venture capital. Shares can become overvalued – this means that investors can make a lot of money, but losses can arise just as quickly. Growth stocks tend to be more volatile than value but offer a greater chance of making significant profits.
Growth companies are normally fairly young, innovative businesses, usually in the technology or healthcare sector.
How Market Conditions Affect Investments
The efficient market hypothesis suggests that at any given time, any information in the public domain is already factored into a share price. This means it is difficult for any one individual to gain an advantage.
Value investors disagree. While most of the information about a company is available to the public, most investors are not accountants and do not spend time analysing balance sheets. Of course, the largest investors (fund managers and banks) will do this, and their trades are significant enough to influence the whole market. But not everyone will interpret the information in the same way.
Value stocks tend to perform well when the economy is starting to expand following a recession, or when interest rates are rising. Growth stocks usually produce higher returns when the economy is growing and interest rates are low, making it easier to borrow.
The conventional wisdom is that value stocks outperform growth over the longer term. According to Bank of America, value investors received more than double the returns of growth investors since 1926.
Of course, this is only part of the story. Most investors will invest for a much shorter time period, which means economic trends might have more of an impact. For example, over a 20 or 30 year investment horizon, the results could be very different.
We also need to consider how technology factors in. High growth tech companies are a fairly recent invention, but today, Apple, Microsoft, Alphabet (Google), and Amazon make up a significant portion of the world’s economy.
The reality is that either value or growth could take the lead at any given time depending on the economic cycle.
What Should You Invest In?
Diversification is the key to a successful investment plan. It’s a good idea to hold a wide range of investments from different asset classes, sectors, company sizes, and world regions. This means that you benefit from market returns without concentrating too much risk in one area.
Diversifying between value and growth is also worth considering. This means benefiting from the long-term, steady returns of value investing, as well as the high profit potential of growth investing. It also means that when the market rotates to favour one or the other, that you don’t miss out.
Choosing individual stocks is time consuming and requires strong analytical skills. Most individual investors don’t have the resources or the skills to do this effectively.
Buying a fund means that most of this work is done for you. The fund manager will purchase a range of shares, which offers built-in diversification. You can buy funds which are value or growth oriented, or simply choose a globally diversified fund which includes a mix of both.
Other Factors to Consider
As well as considering value versus growth, there are a number of other factors that will affect your returns:
- The cost of your investments.
- The tax treatment.
- The risk level, i.e. the mix of equities compared with other, lower-risk investments and your own capacity for financial loss
- Good investor discipline – trying to time the market or making emotional investment decisions can reduce your returns.
- Time in the market. Investing for the long-term is likely to be the best way to achieve growth.
Please don’t hesitate to contact a member of the team to find out more about your investment options.
The value of an investment and the income from it could go down as well as up. The return at the end of the investment period is not guaranteed and you may get back less than you originally invested.
The content in this article was correct on 24/11/2023.
You should not rely on this article to make important financial decisions. Teachers Financial Planning offers independent financial advice on savings, pensions, investments, protection and mortgages for teachers and non-teachers.
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