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Growth vs. Value: Two Approaches to Stock Investing

Key Points

» Defining Features of Growth and Value Stocks
» Growth and Value Are Complementary
» Growth vs. Value: Compare the Performance
» Combining Growth and Value
» Points to remember

Growth and value are two fundamental approaches in stock and stock
mutual fund investing. Many growth stock mutual fund managers look
for stocks of companies that they believe offer strong earnings
growth potential, while value fund managers look for stocks that
appear undervalued by the marketplace. Some fund managers combine
the two approaches.

Growth and Value Defined 

Growth stocks represent companies that have demonstrated
better-than-average gains in earnings in recent years and are
expected to continue delivering high levels of profit growth. While
earnings of some companies may be depressed during periods of
slower economic growth, growth companies may potentially continue
to achieve high earnings growth regardless of economic conditions.
“Emerging” growth companies are those that have the potential to
achieve high earnings growth, but have not established a history of
strong earnings growth.

Value stocks generally have fallen out of favor in the marketplace
and are considered bargain-priced compared with book value,
replacement value, or liquidation value. Typically, value stocks
are priced much lower than stocks of similar companies in the same
industry. This lower price may reflect investor reaction to recent
company problems, such as disappointing earnings, negative
publicity, or legal problems, all of which may raise doubts about
the companies’ long-term prospects. The value group may also
include stocks of new companies that have yet to be recognized by

The primary measures used to define growth and value stocks are the
price-to-earnings ratio (the price of a stock divided by the
current year’s earnings per share) and the price-to-book ratio
(share price divided by book value per share). Growth stocks
usually have high price-to-earnings and price-to-book ratios, which
means that these stocks are relatively high-priced in comparison
with the companies’ net asset values. In contrast, value
stocks have relatively low price-to-earnings and price-to-book

Defining Features of Growth and Value Stocks

Growth Stocks

  • Higher priced than broader market
  • High earnings growth records
  • Less sensitive to economic conditions than broader market

Value Stocks

  • Lower priced than broader market
  • Currently priced below similar companies in industry
  • Carry more risk than broader market

Growth and Value Are Complementary 

Following a specific investment style, such as growth or value,
provides investment managers with guidelines for choosing stocks.
Growth fund managers look for high-quality, successful companies
that have posted strong performance and are expected to continue to
do well, though there are no guarantees. Investors are willing to
pay high price-to-earnings multiples for these stocks in
expectation of selling them at even higher prices as the companies
continue to grow. The risk in buying a given growth stock is that
its lofty price could fall sharply on any negative news about the
company, particularly if earnings disappoint Wall Street.

Value fund managers look for companies that have fallen out of
favor but still have good fundamentals. They buy these stocks at
bargain prices below the stocks’ average historic levels or
below the current levels in their industry groups. Many value
investors believe that a majority of value stocks are created due
to investors’ overreacting to negative events. The idea behind
value investing is that stocks of good companies will bounce back
in time when the true value is recognized by other investors. But
this recognition of value may take time to emerge and, in some
cases, may never materialize.

Which strategy — growth or value — is likely to produce
higher returns over the long term? The battle between growth and
value investing has been going on for years, with each side
offering statistics to support its arguments. Some studies show
that value investing has outperformed growth over extended periods
of time on a value-adjusted basis. Value investors argue that a
short-term focus can often push stock prices to low levels, which
creates great buying opportunities for value investors.

Growth vs. Value: Compare the
Both growth and value stocks have taken turns leading and
lagging one another during different markets and economic
Source: Standard & Poor’s.
Stocks are represented by the annual total returns of S&P/Citi
500 Growth and Value Indexes, which are unmanaged indexes
considered representative of growth and value large-cap stocks.
Index performance results do not take into account the fees and
expenses of the individual investments that are tracked. Results
include reinvested dividends. Past performance is no indication of
future results. Individuals cannot invest directly in an index.

Combining Growth and Value 

For many mutual fund investors, however, there may not be an
absolute advantage to any single approach to investing over a long
period of time. Instead of choosing only one approach, individual
investors may strive for the best-possible returns with the minimum
risk by combining growth and value investing. This approach allows
investors to potentially gain throughout economic cycles in which
the general market situations favor either the growth or value
investment style. For example, value stocks, often stocks of
cyclical industries, tend to do well early in an economic recovery;
growth stocks, on the other hand, tend to lead bull markets, which
are normally fueled by falling interest rates and increased company
earnings. Also, because the two groups of stocks tend not to move
in the same direction or to the same extent, investors can enhance
return potential and reduce risk by combining the two

Points to Remember 

  1. Growth and value are two approaches, or “styles,” of investing
    in stocks.
  2. Portfolio managers use an investment style to describe their
    rules for selecting securities.
  3. Value investors seek stocks that are priced near or below the
    value of the company’s assets. Growth investors seek companies
    that are growing earnings rapidly.
  4. Because they take time to turn around, value stocks may be more
    suited to longer-term investors and may carry more risk of price
    fluctuation than growth stocks.
  5. Individual investors who purchase mutual funds can combine the
    two investment styles to help lower risk.

© 2010 Standard & Poor’s Financial Communications. All
rights reserved.