Retirement Investor: Growth Vs. Value
If I am overweight “growth” investments this year, why is my portfolio growing… so… slowly?
In this post I will address a term often confused by novice and experienced investors alike. Generally investors seek to either grow their assets, create income from their assets or a combination of both. Unfortunately, there is confusion surrounding the application of the word “growth”.
First, let’s assume you want to grow the assets you have through investing. You can do this in a number of ways: You can buy stocks. You can buy bonds. You can buy a mixture of both. Today, let’s consider just one widely used asset class you can use to grow your assets: stocks. Further, we will focus on “growth stocks” and “value stocks”. Let’s define both.
‘Growth Stocks’ vs. ‘Value Stocks’
A growth stock is a share of a company whose earnings are expected to grow at an above-average rate relative to the market. Growth stocks typically do not want to pay dividends. Growth companies would prefer to reinvest retained earnings back into the company. Growth investors often choose stocks based on the potential for capital gains, not dividend income. For this reason, growth stocks are generally more volatile than value stocks.
Growth stocks usually trade at a premium to the overall market. Often growth stocks trade at 20 or 22 times earnings per share (or 300 for Netflix as of writing) in the anticipation the company will grow its’ profits very quickly. Subsequently, the price of a growth stock can fall back to earth quickly if they do not meet business performance expectations of investors.
A value stock is a stock that tends to trade at a lower price relative to its fundamentals (e.g., dividends, earnings and sales). Thus it is considered undervalued by an investor. Common characteristics of such stocks include a higher dividend yield, low price-to-book ratio and/or low price-to-earnings ratio.
Value stocks tend to trade at much lower price to earnings ratio. Often a value stock will trade at 13 times earnings per share and often as low as 10 times earnings per share if they are out of favor (investors have little expectation). During the technology boom of 2000 both financial and energy companies (value stocks at the time) were inexpensively priced with little investor interest or expectation.
Everyone’s Talking About Growth But Value Outperforms
Getting past all of the definitions is where it get’s interesting. Value stocks have historically outperformed growth stocks. Seeing the definition of both, you may no longer wonder why. Unfortunately, many investors remain significantly overweight growth stocks. Why? Because economic and market analysts speak to “growth” and subsequently, we confuse the use of that “growth” with that of “growth stocks” and “growth mutual funds”. Additionally, media outlets generally prefer to discuss dynamic, high expectation, fast growing and innovative “growth” companies… that often crash when they disappoint financially.
To answer the title question: Why is my ‘growthy’ portfolio growing so slowly this year? Well, growth stocks can be out of favor with investors in any given year and value stocks will often outperform in such a year. History has shown us repeatedly this is the long term norm, rather than the exception.
* Investors should consider the investment objectives, risks, charges and expenses of an investment carefully before investing. Fund prospectuses should be read carefully before investing. Investing involves risk and investors may incur a profit or a loss, including the loss of all principal.
Definitions pulled from Investopedia, doctored significantly but nonetheless, should be attributed.
Please Note: Speak to your tax, legal or financial advisor for specific advice about your particular plans and situation.
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