Value Stock Vs. Growth Stock Risk
Stocks represent shares of a company. Individuals purchase these shares in order to invest in a company and receive financial benefits in the form of dividends, which are quarterly payouts of business profits, or stock gains, where the price of the stock goes up. When deciding to purchase stock in a company, investors must decide whether to purchase the safer growth stocks or the riskier value stocks.
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How are they valued?
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Growth stocks include shares in well-established companies, whose earnings can be predicted with reasonable accuracy. These stocks usually go up faster than the market average. They have high price-to-earnings ratios, meaning that they are valued more by investors. Value stocks feature a lower price-to-earnings ratio, which may mean that they are undervalued by investors. Alternatively, these stocks may have a lower P/E, because they are a poor investment.
What are they?
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Growth stocks usually offer high dividends because they are well established companies. In America, corporations such as General Electric, Caterpillar, and Wal-Mart would be examples of growth companies. They usually have an annual growth rate of between five and seven percent. Value stocks usually aren't as well known, but could have once been prestigious companies that could improve in the future. Other times, good companies receive bad publicity or hire incompetent management, which temporarily lowers their stock price. Investors look for undervalued stocks, which have a low level of corporate debt for their price. The prices of value shares are usually undervalued when compared to the book value of the company.
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What are the benefits?
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Growth stocks offer an established track record, therefore leading to less perceived risk. During a market decline, blue chip stocks lose less of their value, as growth stocks are perceived as a safe haven. Investors thinking about a long term strategy may choose solid companies, which will provide reliable results. Value stocks can lead to much greater returns over a shorter period of time. An investor skilled at picking under-priced stocks can reap rewards, when these companies return to their true value.
Considerations
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Stock portfolios should include a mixture of investments, some of which entail more risk than others. Balancing reliable growth stocks with undervalued stocks can provide greater returns, while lowering potential risk. During an economic downturn, there will be many value stocks that are excellent investments, due to depressed prices. During an economic upturn, value stocks are usually few and far between.
Expert Insight
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While growth stocks may seem to offer a safer investment, a study of the Fama-French index model from July 1963 to April 2002 showed that small growth companies had an annualized return of 9.7 percent, while small value companies had an annualized return of 17.6 percent. Growth stocks had a standard deviation of 24.6 percent, while value stocks had a standard deviation of 19.2 percent, meaning that value stocks were less risky, according to the model. Despite these results, Fama and French still recommend purchasing growth stocks in addition to value stock holdings.
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References
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