Value or Growth Stocks ?

Growth stocks are considered stocks that have the potential to outperform the overall market over time because of their future potential, while value stocks are classified as stocks that are currently trading below what they are really worth and will therefore provide a superior return. Which category is better? The comparative historical performance of these two sub-sectors yields some surprising results.

Growth stocks are expected to outperform the overall market over time because of their future potential.

Value stocks may trade below what they are really worth and will therefore theoretically provide a higher return.

The question of whether a growth or value stock investing strategy is better must be evaluated in the context of an individual investor’s time horizon and the amount of volatility, and thus risk, that can be endured.

Growth Stocks vs. Value stocks

The concept of a growth stock versus one that is considered to be undervalued generally comes from the fundamental stock analysis. Growth stocks are considered by analysts to have the potential to outperform either the overall markets or else a specific subsegment of them for a period of time.

Growth stocks can be found in small-, mid- and large-cap sectors and can only retain this status until analysts feel that they have achieved their potential. Growth companies are considered to have a good chance for considerable expansion over the next few years, either because they have a product or line of products that are expected to sell well or because they appear to be running better than many of their competitors and are thus predicted to gain an edge on them in their market.

Value stocks are usually larger, more well-established companies that are trading below the price that analysts feel the stock is worth depending on the financial ratio or benchmark that it is being compared to. For example, the book value of a company’s stock may be $ 25 a share, based on the number of outstanding shares divided by the company’s capitalization. Therefore, if it is trading for $ 20 a share at the moment, then many analysts would consider this to be a good value play.

Stocks can become undervalued for many reasons. In some cases, public perception will push the price down, such as if a major figure in the company is caught in a personal scandal or the company is caught doing something unethical. But if the company’s financials are still relatively solid, then value-seekers may see this as an ideal entry point, because they figure that the public will soon forget about whatever happened and the price will rise to where it should be. Value stocks will typically trade at a discount to either the price to earnings, book value or cash flow ratios.

Of course, neither outlook is always correct, and some stocks can be classified as a blend of these two categories, where they are considered to be undervalued but also have some potential above and beyond this. Morningstar Inc., therefore, classifies all of the equity and equity funds that ranks it in either a growth, value, or blended category.

Which Is Better?

When it comes to comparing the historical performances of the two respective sub-sectors of stocks, any results that can be seen must be evaluated in terms of time horizon and the amount of volatility, and thus risk that was endured in order to achieve them.

Value stocks are at least theoretically considered to have a lower level of risk and volatility associated with them because they are usually found among larger, more established companies. And even if they don’t return to the target price that analysts or the investor predict, they may still offer some capital growth, and these stocks also often pay dividends as well.

Growth stocks, meanwhile, will usually refrain from paying out dividends and will instead reinvest retained earnings back into the company to expand. Growth stocks’ probability of loss for investors can also be higher, particularly if the company is unable to keep up with growth expectations.

For example, a company with a highly touted new product may indeed see its stock price plummet if the product is a dud or if it has some design flaws that keep it from working properly. Growth stocks, in general, possessing the highest potential reward, as well as risk, for investors.

A growth fund is a diversified portfolio of stocks that has capital appreciation as its primary goal, with little or no dividend payouts. The portfolio mainly consists of companies with above-average growth that reinvest their earnings into expansion, acquisitions, and / or research and development (R&D). Most growth funds offer higher potential capital appreciation but usually at above-average risk.

Growth Fund Explained

This high-risk, high-reward mantra makes growth funds ideal for those not retiring anytime soon. Investors need a tolerance for risk and a holding period with a time horizon of five to 10 years. Growth fund holdings often have high price-to-earnings and price-to-sales multiples. This trade-off from investors is the above-average revenue and earnings gains these companies produce.

Main Type of Mutual Fund

Growth funds, along with value funds and blend funds, are one of the main types of mutual funds. They are more volatile than funds in the value and blend categories. Growth funds are typically split by market capitalization, with funds representing small-cap, mid-cap, and large-cap groupings.

Large-cap growth funds are the biggest class of growth funds with a 9.9% market share and $ 2.2 trillion in assets. This trails only large-blend funds, which offer investors value and growth. Large-blend funds have a 15.9% market share. Foreign large-cap growth funds rank 11th of all mutual fund classes with a 2.3% market share.

Foreign growth funds are becoming more common for investors who want to take advantage of global growth. These funds invest in international stocks posting strong revenue and earnings growth. For international growth funds, technology and consumer sectors are the most common. Large internet names such as Tencent, Baidu, and Alibaba can be found among the top 10 holdings for many international growth funds.

The Largest Growth Fund

As of 2018, the largest growth fund is the Growth Fund of America from American Funds. This mutual fund has $ 180.8 billion in assets under management (AUM). It continues to perform well with an average gain of 8.5% annually over the last 10 years.

The Growth Fund of America has Amazon.com Inc. as its largest holding, representing 5.8% of assets. Technology stocks represent the largest sector weighting at 27.3%. Consumer discretionary stocks closely follow with 20.8% of assets.

Technology stocks are a major part of growth funds. With high growth and high price-to-earnings and price-to-sales valuations, technology stocks fit the criteria perfectly for growth funds.

Performance of Growth Funds

With the bull market of the past decade, growth stocks have been on a loom, lifting the returns of growth funds compared to their value and kindred income. Large growth U.S. equity funds have returned 13.5% annualized for the past five years, making them one of the best-performing types of asset classes. By contrast, large value U.S. equity funds, which invest in slower-growing, low-priced stocks, appreciated 9.5% for the same period, and high-yield bonds offered only 3.34%.

Historical Performance

Although the above paragraph suggests that growth stocks would post the best numbers over longer periods, the opposite has actually been true. Research analyst John Dowdee published a report on the Seeking Alpha website where he broke stocks down into six categories which reflected both the risk and returns for growth and value stocks in the small-, mid- and large-cap sectors, respectively.

The study reveals that from July 2000 until 2013, when the study was conducted, value stocks outperformed growth stocks on a risk-adjusted basis for all three levels of capitalization — even though they were clearly more volatile than theirs.