What is Growth Versus Value in Investing
It seems lately, I've had many conversations with both clients and potential clients about some of the basics of financial planning and finance in general. Because I view a large part of my role of being a CERTIFIED FINANCIAL PLANNER™ and financial coach as also being an financial educator, I like to not only help people with their finances but also understand why we do what we do. This means helping those around me understand some more basic terminology that those in the finance fields typically take for granted.
One thing that happens all too often in finance is terminology mix-up. For example, I recently published a blog about the differences between risk and volatility. Unfortunately, these two terms are often used interchangeably, especially in more casual circles. However, the differences between these terms could ultimately lead to some very unfortunate misunderstandings regarding clear and proper communication with someone who's helping you plan your financial future.
While a bit different, today's topic is similar in a way, we're going to be discussing some nuances surrounding the terms growth and value. As you'll soon see, while growth and value can have similar meanings in some instances, they're two unique terms, and understanding their differences and similarities could prove incredibly useful when deliberating and planning your finances. In addition, precise and proper use of these terms will lubricate the wheel of communication between you, your financial planner, financial coach, bank, tax preparer, or whoever else you may speak in-depth with about your finances and financial goals.
What is Growth?
Growth is necessary in our lives. Our journey in growth starts when we are born and as we age we grow in different ways. Personal growth, Professional Growth, Financial Growth... as Michelangelo once said... "I am still learning".
The trick here is that both terms (growth and value) have multiple definitions. This can often and quickly lead to confusion in conversation as sometimes it can be challenging to decipher which definition is being utilized. We all know the more common definition of growth. Growth colloquially is when something gets larger, gains traction, or extends. This standard definition of growth can, and often is, used in finance. We talk about growing wealth, growing your savings, personal growth, etc. However, there is another meaning to the word growth in finance and investing.
What is a Growth Stock?
As stated, growth in finance and investing doesn't only refer to the simple act of something getting larger or growing. Growth is often used to define a stock or investment strategy that highly utilizes growth stocks. But what are growth stocks?
In investing, there is something called growth rate. This is the rate at which an investment (typically a stock) gains value or increases in monetary terms. The average growth rate of a stock moves up or down depending on the overall market and market of any particular investment. The stock of a company with a growth rate above the average market growth rate is what we refer to as a growth stock.
A growth investing strategy highlights and uses critical metrics of the past in an attempt to identify stocks that will have a higher-than-average growth rate going forward. In other words, investors using this strategy try to buy a stock when it has what they believe to be a low price in hopes that it will grow at a rapid pace and allow them to sell at a higher price point and reap the rewards of capital gains (or money made from buying and selling an investment.
What is Value, a Value Stock, or Value Investing?
Value, like growth, has a standard definition as well as a financial definition. Value, even in more familiar terms, has multiple meanings. For example, value can mean how much something is worth, or it could be referring to something that is a "good deal."
However, the term value takes on a new definition when talking about investing. Or, more accurately, it sort of melds the previous two descriptions into one. A value stock or investment is one that investors feel is both being offered for a reasonable price or may be considered undervalued. This is attractive to investors because they believe that the value stock they're buying will "correct" or appreciate its actual value over time. Because value stocks and investments are often challenging to find and identify, they're referred to as "hidden gems." A value investing strategy focuses on stocks and investments perceived as undervalued.
(As always, I suggest doing a little due diligence before making investments)
Telling the Difference Between the Growth and Value
Growth and value are obviously two different things. Growth is something that is growing, while value is something that is either valuable or a good deal. These two simplified definitions pave the way to understanding the differences between growth and value stocks and investment strategies. A growth stock has yet to achieve its potential; it's new or growing into hopeful maturity. On the other hand, a value stock is one that's seen some amount of success in the past and is undervalued for the time being.
Theoretically, there are many ways to differentiate between the two types of investments and investment strategies. However, it's easier to see how they're similar (which is perhaps why they're so often mixed up). The goal of either one of these investments or strategies is to identify something priced low and will increase in price and sell for a profit in a reasonable amount of time.
NerdWallet states, "Value investors look for companies that have already earned their stripes and have a stock price that's lower than it should be (and may rise again to reflect that). Growth investors look for companies with future potential and expect the stock price to increase (even if it's already relatively high) as the companies reach or exceed that potential. Same desired destination, different ways of getting there."
Combining Growth and Value into an Overall Strategy.
According to Merrill, value stocks do well in cycles and perform incredibly well during an economic recovery. In contrast, growth stocks tend to have better earnings overall with worse repercussions during slow economic times. Both types of investments and strategies have ebb and flow and have their place in the world.
As you might expect, there's a hot ongoing debate about the differences, similarities, and efficacy of growth and value investments and strategies. Both growth and value acolytes will tell you their way is best and the most proven. However, as with many things, the truth may fall somewhere in the middle. In many professionals ' opinions, the best types of investment plans are those that take advantage of the prospects of multiple strategies. In other words, there's not necessarily a reason that you must choose between value and growth. In fact, the two can work well together in a portfolio that's aimed at a more long-term wealth-building strategy.
Using both growth and value in a long-term investment strategy in conjunction with a financial coach or CERTIFIED FINANCIAL PLANNER™ will likely be your best bet. While it's good to know what's going on so you can be in the know and provide input to those who are helping you along your financial journey, the simple fact is that all of these terms, strategies, and plans are a full-time occupation. That's why I always recommend working with someone who can help guide you along the way and has the expertise to fill in the gaps.
If you'd like to learn more about the similarities and differences between growth and value, please, feel free to call or email to schedule an appointment with me. Together, we can create a financial plan that keeps your investment preferences in mind and align your investments with your financial needs and goals.
Until next time...this is Melissa Making Cents!
Melissa Anne Cox, CERTIFIED FINANCIAL PLANNER™, is also a College Planning and Student Loan Advisor and Financial Coach in Dallas, Texas.