Value or Growth Stocks: Which Is Better?

investopedia.com/articles/professionals/072415/value-or-growth-stocks-which-best.asp

Mark P. Cussen

Growth stocks are those companies that are considered to have the potential to
outperform the overall market over time because of their future potential. Value stocks are
classified as companies that are currently trading below what they are really worth and
will thus provide a superior return.

Which category is better? The comparative historical performance of these two sub-
sectors yields some surprising results.

Key Takeaways
Growth stocks are expected to outperform the overall market over time because of
their future potential.
Value stocks are thought to trade below what they are really worth and will thus
theoretically provide a superior return.
The question of whether a growth or value stock investing strategy is better must be
evaluated in the context of an individual investor's time horizon and the amount of
volatility, and thus risk, that can be endured.

Growth Stocks vs. Value Stocks

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The concept of a growth stock versus one that is considered to be undervalued generally
comes from the fundamental stock analysis. Growth stocks are considered by analysts to
have the potential to outperform either the overall markets or else a specific subsegment
of them for a period of time.

Growth stocks can be found in small-, mid-, and large-cap sectors and can only retain this
status until analysts feel that they have achieved their potential. Growth companies are
considered to have a good chance for considerable expansion over the next few years,
either because they have a product or line of products that are expected to sell well or
because they appear to be run better than many of their competitors and are thus
predicted to gain an edge on them in their market.

Value stocks are usually larger, more well-established companies that are trading below
the price that analysts feel the stock is worth, depending upon the financial ratio or
benchmark that it is being compared to. For example, the book value of a company’s
stock may be $25 a share, based on the number of shares outstanding divided by the
company’s capitalization. Therefore, if it is trading for $20 a share at the moment, then
many analysts would consider this to be a good value play.

Stocks can become undervalued for many reasons. In some cases, public perception will
push the price down, such as if a major figure in the company is caught in a personal
scandal or the company is caught doing something unethical. But if the company’s
financials are still relatively solid, then value-seekers may see this as an ideal entry point,
because they figure that the public will soon forget about whatever happened and the
price will rise to where it should be.

Value stocks will typically trade at a discount to either the price to earnings, book value, or
cash flow ratios.

Of course, neither outlook is always correct, and some stocks can be classified as a
blend of these two categories, where they are considered to be undervalued but also
have some potential above and beyond this. Morningstar Inc., therefore, classifies all of
the equities and equity funds that it ranks into either a growth, value, or blended
category.1

Which Is Better?
When it comes to comparing the historical performances of the two respective sub-
sectors of stocks, any results that can be seen must be evaluated in terms of time horizon
and the amount of volatility, and thus risk that was endured in order to achieve them.

Value stocks are at least theoretically considered to have a lower level of risk and volatility
associated with them because they are usually found among larger, more established
companies. And even if they don’t return to the target price that analysts or the investor
predict, they may still offer some capital growth, and these stocks also often pay
dividends as well.

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Growth stocks, meanwhile, will usually refrain from paying out dividends and will instead
reinvest retained earnings back into the company to expand. Growth stocks' probability of
loss for investors can also be greater, particularly if the company is unable to keep up
with growth expectations.

For example, a company with a highly touted new product may indeed see its stock price
plummet if the product is a dud or if it has some design flaws that keep it from working
properly. Growth stocks, in general, possess the highest potential reward, as well as risk,
for investors.

Historical Performance
Although the above paragraph suggests that growth stocks would post the best numbers
over longer periods, the opposite has actually been true. Research analyst John Dowdee
published a report on the Seeking Alpha website where he broke stocks down into
categories that reflected both the risk and returns for growth and value stocks in the
small-, mid-, and large-cap sectors, respectively.2

The study reveals that from July 2000 until 2013, when the study was conducted, value
stocks outperformed growth stocks on a risk-adjusted basis for all three levels of
capitalization—even though they were clearly more volatile than their growth
counterparts.2

But this was not the case for shorter periods of time. From 2007 to 2013, growth stocks
posted higher returns in each cap class. The author was forced to ultimately conclude
that the study provided no real answer to whether one type of stock was truly superior to
the other on a risk-adjusted basis. He stated that the winner in each scenario came down
to the time period during which they were held.2

A Different Study
However, Craig Israelsen published a different study in Financial Planning magazine in
2015 that showed the performance of growth and value stocks in all three capsizes over a
25-year period from the beginning of 1990 to the end of 2014.

The returns on this chart show that large-cap value stocks provided an average annual
return that exceeded that of large-cap growth stocks by about three-quarters of a percent.
The difference was even larger for mid-, and small-cap stocks, based on the performance
of their respective benchmark indices, with the value sectors again coming out the
winners.3

But the study also showed that over every rolling five-year period during that time, large-
cap growth and value were almost evenly split in terms of superior returns. Small-cap
value beat its growth counterpart about three-quarters of the time over those periods, but
when growth prevailed, the difference between the two was often much larger than when
value won. However, small-cap value beat growth almost 90% of the time over rolling 10-
year periods, and mid-cap value also beat its growth counterpart.3

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The Bottom Line
The decision to invest in growth vs. value stocks is ultimately left to an individual
investor’s preference, as well as their personal risk tolerance, investment goals, and time
horizon. It should be noted that over shorter periods, the performance of either growth or
value will also depend in large part upon the point in the cycle that the market happens to
be in.

For example, value stocks tend to outperform during bear markets and economic
recessions, while growth stocks tend to excel during bull markets or periods of economic
expansion. This factor should, therefore, be taken into account by shorter-term investors
or those seeking to time the markets.

Article Sources

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1. Morningstar. "Morningstar Report: Mutual Fund Data Definitions." Accessed Aug. 2,
2020.

2. Seeking Alpha. "Value Versus Growth: Which Is Better?" Accessed April 2, 2020.

3. Financial Planning. "Can Value Investing Still Trump Growth?" Accessed April 2,
2020.

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