Returns from growth investing have substantially greater than those from value investing over the last decade. Looking back over the last 100 years or so, this isn’t the norm. Will value ever come back, or is growth here to stay? This post will examine the history, along with both sides of the argument.
So What Is a Value or Growth Stock, Exactly?
The investing world likes to categorize stocks in a number of different ways. Geography and size are two of the most popular methods. Another way is value vs. growth. Value stocks tend to be older, more established companies with “cash cow” type businesses. They don’t typically create exciting new technologies that might set the world on fire, but they have stable revenue and profit streams, and often distribute a portion of their earnings back to shareholders through a dividend. Think of companies like GE, Exxon Mobile, or Home Depot.
Growth companies operate a little differently. They typically reinvest 100% of their earnings back into the company to fuel future growth, rather than pay dividends to shareholders. They often have new products, services, or technologies that are spreading around the world like wildfire. Your FANG stocks are great examples of typical growth companies: Facebook, Amazon, Netflix, and Google. All have new technologies, services, or models that are taking the world by storm.
From an investment point of view, the reason you might buy a value stock is completely different than why you might buy a growth stock. In a value investment, you’re purchasing company shares because you think they’re worth more than the current market price. “Undervalued” is a common term you’ll hear in a value investment strategy. Metrics you might track to make this determination are price to earnings ratio, price to book ratio, or dividend yield.
Current share prices don’t matter as much in growth investments. In a growth investment you’re not buying a stock because you think it’s cheap; you’re buying it because you think the company will continue growing at an above average rate. Look at companies like Amazon. They’re terribly expensive on a valuation basis, but that doesn’t deter investors in the least. The company is growing so rapidly that the expensive valuation simply doesn’t matter to those buying shares. Metrics you might track here are earnings growth rate, EBITDA (earnings before interest, taxes, depreciation & amortization), or momentum.