Value vs Growth Investing Strategies

When building an investment portfolio, one of the key strategic decisions is choosing between value vs growth investing approaches. Value investing aims to select undervalued stocks trading below intrinsic value, while growth investing targets appreciating shares of companies experiencing rapid expansion. This guide examines how value and growth investing differ, when each is advantageous, and how investors can blend both strategies.

What is Value Investing?

Value investing involves selecting stocks trading at discounts compared to their true inherent worth based on business fundamentals. Key tenets include:

Seeking shares with low price-to-earnings, price-to-book value, and price-to-sales ratios signaling undervaluation.
Focusing on companies with strong balance sheets and financials but temporarily fallen out of market favor.
Holding long-term, avoiding frequent trading.
Reliance on detailed in-house research vs following Wall Street consensus.
Investing in “margin of safety” buffer between market price and estimated intrinsic value.
Exploiting market psychology and biases that cause mispricing.

Value investors purchase shares they estimate to be worth significantly more than current valuations, expecting eventual correction and multiples expansion.

What is Growth Investing?

Growth investing focuses on companies experiencing surging expansion compared to overall markets. Characteristics include:

Targeting stocks with expected earnings, revenue and market share growth above industry and market averages.
Seeking companies aggressively reinvesting to drive innovation and capture new opportunities.
Avoiding traditional value ratios; high growth justifies lofty valuations.
Monitoring surging customer demand for products or services.
Riding momentum from rising investor sentiment which propels growth stock prices up further.
Favoring emerging leaders in rapidly developing industries.

Growth investors buy stocks poised to appreciate substantially when disruptive companies thrive and dominate new markets.

Key Differences Between Value vs Growth

While both aim to produce market-beating returns, value and growth investing differ significantly:

Valuation Metrics

Value – Low price-to-earnings, book, sales, cash flow ratios signal undervaluation.

Growth – High price-to-earnings ratios acceptable given expected expansion.

Fundamentals

Value – Financially sound if temporarily struggling companies.

Growth – Rapidly growing but not always profitable companies.

Industries

Value – Mature industries like manufacturing, financials, utilities.

Growth – New technology, biotech, internet, renewable energy sectors.

Investment Horizon

Value – Long-term holdings, years.

Growth – Ride momentum wave, sell when growth peaks.

Risk Tolerance

Value – Moderate risk tolerance.

Growth – Higher risk appetite.

There are pros and cons to both approaches. Most portfolios selectively combine value and growth stocks.

When to Use Value Investing Strategies

Value investing tends to perform well during periods of market uncertainty and instability when investors flee to the perceived safety of stable companies trading at discounts. Consider tilting your portfolio more toward value when:

1. Bull Markets Slow Down

As bull markets show signs of plateauing after extended runs, value stocks become more compelling relative to pricey growth names.

2. Inflation Is High

Rising inflation favors value stocks which hold tangible assets. Growth stocks must meet higher future earnings hurdles when discount rates increase.

3. Index Performance Diverges

When growth stocks surge far ahead of value benchmarks for prolonged periods, market mean reversion kicks in favoring neglected value stocks at some point.

4. Investor Pessimism Rises

During recessions or times of fear like wars, pandemics, or uncertainty, value stocks exhibiting steadiness often attract traders exiting riskier growth fare.

5. You Have a Long Time Horizon

Value stocks exhibit less volatility over multi-decade periods. Investors with longer time horizons can wait for underpricing to correct.

Tilting your portfolio allocation toward value stocks or funds helps protect capital when risk appetite declines.

When to Use Growth Investing Strategies

Growth investing is most rewarding during economic booms and bull runs when investors embrace risk and reward future potential over current valuation metrics. Consider upping growth exposure when:

1. The Economy Is Expanding

A strong growing economy provides the ideal backdrop for growth companies to invest and capture share in thriving markets.

2. Interest Rates Are Low

Cheap capital enables financing growth. Higher rates hurt pricey growth stocks reliant on borrowed money to fuel expansion.

3. Consumer Confidence Is High

When consumers and businesses feel optimistic about the future, they buy ahead of growth, fueling earnings.

4. Market Momentum Favors Growth

Growth stocks outperforming for sustained periods tend to continue as investors chase winners and stories.

5. New Technologies Emerge

Growth investing captures disruptive innovations and themes transforming industries like blockchain, AI, cloud computing or biotech breakthroughs.

Ramping up growth stock holdings capitalizes when risk appetites peak and transformative breakthroughs drive profits.

Pros and Cons of Value vs Growth Investing

Each strategy has advantages and drawbacks:

Value Investing Pros

Takes advantage of market mispricing and psychology
Less volatile over long-term
Safeguards capital during uncertainty
High margins of safety limit downside

Value Investing Cons

Undervalued stocks could stay depressed
Miss out on rising growth stocks
Boring companies lack sizzle and pizzazz
Contrarian approach defies market sentiment

Growth Investing Pros

Benefits from momentum and high future returns
Captures high flyers disrupting markets
Not constrained by current fundamentals
Multi-bagger return potential

Growth Investing Cons

Vulnerable to inflated valuations
Higher volatility
Prone to pullbacks when growth slows
Hard to predict winners and losers

Weigh your risk tolerance, market conditions, and goals when deciding allocation.

Tips for Evaluating Value vs Growth Stocks

Assess stocks using these value and growth criteria:

Value Stock Characteristics

Low price-to-earnings ratio (P/E)
Low price-to-book ratio (P/B)
Low price-to-sales ratio (P/S)
Low price-to-cash flow ratio (P/CF)
Low debt-to-equity ratio
High dividend yield
Slow but steady historical growth

Growth Stock Characteristics

High price-to-earnings ratio (P/E)
High projected revenue and earnings growth
Expanding market share
New disruptive products gaining adoption
High consumer demand and brand buzz
Reinvesting heavily in future expansion
Volatile but rising share price trajectory

Compare stocks across these metrics to categorize holdings and ensure you understand what you own.

Blending Value and Growth Investing

Most investors selectively combine both schools of investing for balanced exposure:

Maintain Distinct Value and Growth Buckets

Allocate specific portfolio percentages to dedicated value holdings and growth holdings to fine tune your asset mix.

Complement Core Index Holdings

Surround core index funds representing the overall market with satellite value and growth tilts through active funds or direct stock picking.

Shift Strategies Over Time

Alternate between value and growth overweighting based on which appears primed to outperform under current market conditions.

Focus on Quality

Seek quality value stocks – financially sound companies trading at discounts. And target quality growth – profitable disruptors with real earnings.

Diversify Value Metrics

Look beyond P/E ratios for catalysts like new management, hidden assets, industry tailwinds that could spur revaluation of languishing value stocks.

Thoughtfully combining both approaches allows benefiting from their respective strengths.

Key Value and Growth Benchmark Indexes

These indexes demonstrate long-term performance differences between value and growth approaches:

Russell 1000 Value Index – Tracks large-cap value stocks. Relatively steady returns with fewer drawdowns.

Russell 1000 Growth Index – Benchmarks large-cap growth stocks. Higher volatility with more extreme returns.

S&P 500 Value Index – Measures value performance of stocks in the S&P 500. Significant diversification across sectors.

S&P 500 Growth Index – Reflects growth side of S&P 500. Heavily weighted toward tech sector.

MSCI USA Value Index – Captures mid and large-cap U.S. value stocks. Commonly used international value benchmark.

MSCI USA Growth Index – mid and large-cap growth equivalents of MSCI value index. Significant international exposure.

Compare indexes to relevant market benchmarks to evaluate performance attribution.

Value Investing Strategies

Employ proven value investing strategies:

Deep Value

Target deeply distressed and depressed value stocks trading at huge discounts. Higher risk, higher potential returns.

Dividend Value

Seek undervalued stocks with high dividend yields for steady income and growth. Safety in established dividends.

International Value

Apply value principles to find overseas bargains trading at lower valuations than domestic peers.

Greenwald Method

Invest in 20-30 bargains based on earnings power value using discounted future free cash flow.

Magic Formula

Systematically buy inexpensive stocks with high returns on capital as ranked by a formulaic screen.

Margin of Safety

Insist on a large spread between intrinsic value estimates and purchase price to limit downside.

Net-Net Investing

Focus on net-nets trading below liquidation value to maximize margin of safety.

Growth Investing Strategies

Try these growth investing techniques:

Focus on Earnings Growth Rates

Seeking companies with the highest 1, 3, and 5 year earnings per share and revenue growth forecasts.

Find Market Leaders

Target stocks gaining the most market share within their respective industry groups.

Let Winners Ride

Allow position size to grow in the highest performing growth stocks in your portfolio over time.

High Growth at Reasonable Price

Look for above average growth stocks that haven’t gotten too expensive relative to underlying performance.

Buy the Rumor, Sell the News

Take advantage of speculation and hype by buying expected product announcements and selling once launched.

Invest in What You Know

Focus on emerging companies in sectors you’re familiar with through personal experience.

Whichever strategies you use, maintain discipline around valuation and company fundamentals. Don’t overpay.

Value and Growth Investing Performance

Historically, value stocks outperform over long periods, but growth goes through extended stretches of dominance:

Over 1928-2021, value stocks returned 16.8% vs growth at 12.3%
Value beat growth in the 1950s, 1970s, 1980s, early 2000s, and 2010s
Growth trounced value in 1930s, 1960s, 1990s, and 2010s

This data demonstrates the cyclicality of leadership between the strategies. Holding both allows participating when each is in favor. Patient investing wins over time.

Key Takeaways

Growth stocks focus on rapidly appreciating companies and tend to outperform early in economic cycles.
Value stocks target undervalued companies based on intrinsic worth and tend to outperform later in cycles.
Investors should hold a blend of value and growth stocks tailored to personal risk appetite and market conditions.
Rebalance between value and growth tilts over time based on relative performance and opportunity.

Conclusion

Value and growth are foundational investing philosophies successful investors use to drive outperformance. While conflicting at a surface level, combining the approaches allows playing offense and defense under changing market regimes. Maintain rigorous valuation standards whether selecting seemingly expensive growth stocks or apparently cheap value stocks. Ultimately, buying quality companies, allowing winners to compound, and focusing on long-term fundamentals determines investment success more than adherence to any one style.

FAQs

Should I focus solely on value or growth investing?

Most investors hold a blend of value and growth stocks to maintain balanced exposure. Tilting allocation between value and growth based on changing market conditions helps optimize returns.

Do value and growth stocks perform differently in bull vs bear markets?

Value stocks tend to provide steadier returns with reduced volatility during bear markets. Growth stocks often generate bigger gains in bull markets.

What are the most common metrics used for evaluating value and growth stocks?

Key value metrics are the price-to-earnings, price-to-book value, and price-to-sales ratios. Growth stocks emphasize revenue, earnings per share growth, and future earnings forecasts.

Should young investors focus more on growth stocks?

Younger investors with long time horizons can better endure the volatility of growth stocks. Older investors approaching retirement should emphasize value for stability and income.

Do value stocks pay higher dividends than growth stocks?

Value stocks tend to pay higher dividends because established companies often trade at discounts. However, many growth companies reinvest profits to fuel expansion rather than pay dividends.

What are examples of common value and growth stocks?

Classic value stocks include companies like Berkshire Hathaway, Johnson & Johnson, and Coca-Cola. Growth giants include Tesla, Nvidia, Amazon, and Netflix.

Carefully combining value and growth stocks can enhance long-term returns for patient investors able to withstand volatility.