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Couple talks with their financial advisorInvesting in the stock market can help you build wealth, but deciding what types of stocks to invest in can be challenging. For example, you may be deciding between value and growth stocks and weighing how each of these two styles of investing can help you meet your investment goals. Understanding how value and growth stocks compare is an important step in building a solid portfolio that aligns with your needs and objectives.

What Is a Value Stock?

To understand value stocks, it helps to know a little about value investing. This investment strategy, created by Benjamin Graham and popularized by Warren Buffett, focuses on investing in undervalued stocks that have the most potential to increase in value over time. Essentially, it’s all about finding companies to invest in that are the hidden gems, meaning the market as a whole has either underestimated their worth or overlooked them completely.

A value stock is one that’s deemed a bargain in the market. You’re not necessarily looking for huge, immediate growth from these companies. But you are banking on that stock appreciating in value over time so that you can eventually sell the shares for much more than you bought it for.

Characteristics of a value stock include – but are not limited to – the following:

  • Low price-to-earnings ratio. Price-to-earnings ratio or P/E measures the ratio of a company’s share price to its earnings per share. A below-average P/E ratio, which for all shares considered over the long term is about 16, is one hallmark of a value stock.
  • Lower volatility. Value stocks are often associated with established companies that have a proven track record. That means they tend to be less volatile, meaning fewer broad pricing swings over time.
  • Priced below competitors. Another indicator of a value stock is its price in contrast to its industry peers. If a stock is priced well below the competition, then that could suggest it’s undervalued.
  • Dividends paid to investors. Dividend payouts provide a stream of income to investors. You’re more likely to realize dividends from value than growth stocks.

Additionally, the companies that are typically identified as being value stocks tend to have stable and consistent revenues and cash flows. They’re operating on predictable business models, which can make value stocks a less risky bet compared to growth stocks.

What Is a Growth Stock?

Financial reportsGrowth investors look to the market for investments that are poised to experience significant growth. The main objective is honing on stocks that have huge growth and return potential. In other words, you’re looking for the next big thing.

A growth stock is one that’s positioned to grow quickly, potentially outpacing its competitors by a substantial margin. With this type of investment, it’s not dividends you’re after; instead, you’re banking on a steep climb in the stock’s price so you can sell at a sizable profit.

Characteristics of growth stocks include – but are not limited to – the following:

  • Higher volatility. By nature, growth stocks tend to be riskier because they’re less predictable. If a company is on its way up then it can be harder to gauge how quickly growth will happen, or if it will happen at all.
  • Higher per share prices. Growth stocks are less likely to be undervalued. Instead, their share prices may be higher in relation to their profits or revenues. In other words, you’re less likely to find a bargain when targeting growth stocks over value stocks.
  • Less likely to pay dividends. One key characteristic of growth stocks is that they may be less likely to hand out dividends to investors. Instead, these companies sometimes take any profits or dividends and reinvest them into growth.

Growth stocks, in a nutshell, are ones that investors believe are poised to outperform the broader market. These can be small-cap companies, large-cap companies or anything in between.

Value vs. Growth Stocks: Which Is Better?

Both value and growth stocks have their strong points and whether it makes sense to invest in one or the other depends largely on what you’re trying to achieve with your portfolio.

With that in mind, you might lean toward value stocks if:

  • You’re interested in adding a stream of income to your portfolio. Getting regular dividend payments from value stocks could help supplement income in your working years or retirement.
  • You want to avoid volatility as much as possible. Value stocks are less likely to take you on a bumpy ride, compared to growth stocks. Their underlying companies tend to be stable and consistent so there are no big surprises.
  • You prefer buy-and-hold investing to quick wins. A buy-and-hold strategy involves buying stocks and holding onto them for the long-term. If you want to play the long game with your portfolio, then investing in value stocks and hanging onto them could make sense.

On the other hand, you might prefer growth stocks if:

  • You’re not worried about volatility. If you can stomach the ups and downs that sometimes go along with investing in growth stocks, then you may be comfortable including them in your portfolio.
  • You don’t need dividend payouts. You may also lean toward growth stocks if you don’t necessarily need dividends as an income stream.
  • You’re confident about being able to pick winners. Growth stock investing requires more than just basic knowledge of the stock market. To do it well, you need to have some skill at choosing companies that are poised for imminent capital appreciation.

How to Invest in Value vs. Growth Stocks

A candlestock chartThere are two basic ways to invest in value and growth stocks: buying individual stocks or purchasing mutual or exchange-traded funds.

Buying individual stocks means you can control exactly how many shares of a value or growth company you own. With a mutual fund, you’re pooling your investment dollars with other investors. It’s up to the fund manager to decide how to allocate fund assets across different value or growth stocks.

Buying and selling individual stocks tends to be a little more hands-on. If you’re looking for a more passive investment approach, you could try value or growth index funds. These mutual funds track all of the value or growth stocks in a particular index in an attempt to match its performance.

If you’re interested in getting exposure to both value and growth stocks at the same time, you could also try a blended fund. These funds invest in a mix of value and growth stocks, giving you exposure to both sides of the fence in a single investment.

The Bottom Line

Value stocks and growth stocks operate differently and they can be used to meet different goals in your portfolio. Whether to invest in value or growth stocks is an entirely personal decision that can hinge on how well either one meets your needs and risk tolerance. A blended mutual fund can offer the best of both worlds, but any time you’re investing in mutual funds it’s important to check the historical performance and fees.

Tips for Investing

  • Consider talking to a financial advisor about whether a value or growth investing strategy is the best fit for your financial plan. Finding the right financial advisor who fits your needs doesn’t have to be hard. SmartAsset’s free tool matches you with financial advisors in your area in five minutes. If you’re ready to be matched with local advisors who will help you achieve your financial goals, get started now.
  • When comparing individual stocks, it helps to understand the various approaches you can use. Fundamental analysis, for example, focuses on a company’s fundamentals and overall financial health. Technical analysis involves forecasting a stock’s probable future movements based on past trends. Both can be useful in deciding where to invest your money.

Photo credit: ©iStock.com/Sam Edwards, ©iStock.com/cnythzl, ©iStock.com/nevarpp

Rebecca Lake Rebecca Lake is a retirement, investing and estate planning expert who has been writing about personal finance for a decade. Her expertise in the finance niche also extends to home buying, credit cards, banking and small business. She's worked directly with several major financial and insurance brands, including Citibank, Discover and AIG and her writing has appeared online at U.S. News and World Report, CreditCards.com and Investopedia. Rebecca is a graduate of the University of South Carolina and she also attended Charleston Southern University as a graduate student. Originally from central Virginia, she now lives on the North Carolina coast along with her two children.
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