Why Value Stock Investing Over Growth Stock Investing?
Value stock investing is different from growth-style investing in that value stocks are out of favor due to difficulties either with the company or with the industry the company is in. The rate of earnings growth has a strong bearing on determining one from the other.
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Value Style Investing
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Stocks or industries that are distressed will carry lower prices. These groups can remain out of favor for extended periods and require long time frames for investment. The reason for the lack of favor implies that there is more risk to that stock or group. Value stocks are less volatile than growth stocks.
Growth Stock Investing
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Growth stock investing is defined by companies or industries experiencing high levels of earnings growth. They are more "expensive" than other stocks or groups because investors are willing to pay higher stock prices for that anticipated earnings growth. They are more volatile but are less susceptible economic risk.
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Determining Value
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A very common measure of determining a stock's value is its price-to-earnings multiple (P/E ratio). A $50 stock with annual earnings of $5 will have a P/E of 10-1, whereas a $50 stock with annual earnings of $2.50 will have a P/E ratio of 20-1. If the company's earnings are growing at a high enough rate, it can sustain higher P/E multiples.
Price-to-Earnings Growth
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Knowing a stocks P/E ratio can further identify value when compared to the earnings growth rate. This number (PEG) is a better measure to distinguish growth from value stocks. A company with a P/E of 10 and an earnings growth rate of 10 percent has a PEG of 1 while one with a P/E multiple of 20 and the same earnings growth rate will have a PEG of 2. The lower the PEG, the greater the value.
Future Earnings Prospects
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The earnings a company or industry is expected to generate in the future will have a bearing on the popularity for that stock/group. If prospects are dim, investors will shun that stock and it's price will remain depressed. Stocks with high earnings and growth are more popular at times. Both investment styles rotate in and out of favor.
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