Difference between growth and value stocks
The initial approach is the one thing that confuses beginner investors when they are considering entering the stock market. Where should you start? Which stocks should you buy? The answer will always be Goal-based investing. Goal-based investing means that you set predetermined goals before you enter the stock market. For example, suppose you want to invest for creating a retirement corpus; you look for long-term investments. However, if you want to invest in buying a new bike or a car, you should invest for the short term.
The solution for finding the best initial approach is the most important part to execute the planned strategy through stocks. It means that you choose stocks that are relevant to your goals and achieve them in the short or long term. In the process of goal-based investing, investors look towards two types of shares: Growth stocks and value stocks.
Here’s everything you need to know about goal-based investing through learning about the difference between growth and value stocks.
What are shares?
In simple words, a share indicates a unit of ownership of a particular company. If you own the shares of a company, it implies that you, as an investor, hold a percentage of ownership of the issuing company. These shares are listed on the stock exchanges through the means of an Initial Public Offering, and investors can buy and sell them based on their current price. The entities (individuals or corporations) who buy the shares of any company become the shareholder.
With the definition of shares clearly stated, read ahead to understand the value stocks vs growth stocks definition.
Value stocks vs Growth stocks: Meaning and definition of Growth and Value stock
Value stocks are those that have a unique feature working in their favor which results in the potential to create value over time. Value stocks are associated with big, well-established companies that are trading below their fair market value as per the analysts.
For example, a company’s stocks may be trading at Rs 250 currently. However, analysts may feel that after finding the fair value (outstanding shares divided by the company’s capitalization), the fair book value of the stock is Rs 350. Believing the stock market principle that every stock reaches its fair book value sooner than later, you can invest in these stocks. Value stocks offer regular dividends to the shareholders but do not rise their share price by a huge margin.
Growth stocks are those that present a high-profit potential to investors as their share price rises rapidly. Usually, the growth stocks outperform their peers and the industry, which is amply reflected in the premium valuation commanded in the market by the stocks of such companies. Growth stocks do not promise regular dividends as they prefer investing their profits in expanding the company. Notably, companies with growth stocks are relatively new and not well established. Their goal is to garner as much market share as possible, which they believe is only possible by expanding the business.
How do growth and value stocks work?
In the argument of value stocks vs growth stocks, the idea is simple. It is entirely value vs growth. It is up to the investors to identify their goals of goals-based investing and choose value or growth stocks accordingly. Notably, growth stocks are more volatile than value stocks but have the potential to rise in price substantially. On the other hand, value stocks are low-risk, and offer regular dividends but can’t fulfill short-term investing goals.
The basic idea behind growth and value stocks is to invest in growth stocks to achieve short-term goals and in value stocks for achieving long-term goals. Almost all investors hold value stocks for the long term as it offers them steady returns and appreciates at the share price. As growth stocks usually don’t pay dividends but appreciate by a huge margin, you can invest in them for the short term and sell all of your holding or book profits to cover your expenses.
The best way, as per experts, is to diversify within the growth and value stocks. You can divide your capital and allocate a portion for investing in growth stocks and the rest for investing in value stocks. That way, you can ensure you can achieve both your short and long-term financial goals.
How do identify growth and value stocks?
Growth stocks usually have low dividend yields but above-average valuations. The high valuations commanded by these stocks are measured in terms of price-to-earnings (P/E), market capitalization-to-sales, and price-to-book value ratios (P/B).
In the case of value stocks, companies can run the business with low debt and equity. When the P/E is reasonable, and the earnings are likely to grow exponentially, you have a value stock in front of you. Furthermore, if the ROE (return on equity) and the ROCE (return on capital employed) are above 15% each and both are close to each other, it is the sign of a value stock.
With knowledge about the difference between growth and value stocks, you are better equipped to approach the stock market and start your investing journey. The first step would be to review your finances and determine your short-term and long-term goals. Once you have, you should figure out how much you can invest. The next step would be to open a Demat and trading account. A Demat account is used to hold the shares you buy, and the trading account is used to buy and sell them. You can open the Demat and trading account for free by visiting the IIFL website or downloading the IIFL demat account app from the app store. Once you have opened the two accounts, you can begin identifying growth and value stocks and invest appropriately.
Frequently Asked Questions Expand All
Growth stocks allow investors to make profits as they appreciate their price quicker than any other type of stock. Value stocks allow investors to receive regular dividend payments along with the stock appreciating at price steadily over the long term.