The Difference Between Growth and Value Stocks
By Martin Lukac
What is the difference between a growth stock and a value stock? You've heard the terms in regards to value and growth investing, but you may not be sure what they exactly mean.
There are no hard, set definitions of growth and value stocks. But you will find that there are some criteria that generally defines these different stocks. The trouble often comes with the labeling of individual stocks that are near the edge of either definition.
Growth and value aren't just investing methods, but they are a way for investors to narrow the stocks they will invest in. History has shown us that they tend to take turns. There are periods when growth stocks do well, and other periods in which value stocks excel. The best investment strategy for the average investor is to hold both in a diversified portfolio.
Growth investing involves focusing on a stock that is growing with potential. Value investing seeks stocks that the market has under priced that have a potential for an increase.
Growth stocks usually feature strong growth rates. You want to see small companies with a 10% or higher growth rate for the past five years, while larger companies need to post a 5% to 7% growth rate. You also want to see a strong return on equity. Consider the earnings per share and the pre-tax margins. Look at the projected stock price for a clue of your potential returns.
When considering a growth stock, you need to use your judgment and common sense. The stock might not meet all of the criteria, but still show signs of being a solid growth stock. For example, it may not have a five-year look to see yet, but still be a significant player in a growing new industry.
Value stocks are often confused for cheap stocks, which they are not. However, you may find value stocks listed on the lists of the companies that have hit a 52-week low. Investors look at value stocks as the bargains of investing. The idea is to choose a stock that is under priced and wait for the market price correction. Consider the price earnings ratio, which should be in the bottom 10% of all companies. Look for a price to earning growth ration of less than 1. A good value stock has at least as much equity as debt, twice as much liability as assets and a share price at tangible book value or less.
While there are investors that tend to focus on one type of stock over another, a diversified portfolio of both growth and value stocks will provide you with good returns. If you are a beginning investor, this is an ideal combination. If you find that you have only of them in your holdings, you should consider the benefits of diversification.
Martin Lukac represents RateTake.com Mortgage marketplace. RateTake matches consumers with multiple lenders offering low mortgage rates from our network of accredited lenders.