Perhaps you are ready to start investing on stocks. You have done some research , secured a stock broker and funded your account. What kind of stocks should you consider? Certainly there is no shortage of options. Again your decision should be based on your goals and what type of investor you are. Growth stocks and Value stocks, both have merit, but which one should you choose. I properly balanced portfolio will include both, but for the moment lets investigate growth stocks versus value stocks.
Stocks are priced according to the value of the companies’ earnings in the perfect world. We do not live in a perfect world. That is an understatement, for sure. Growth stocks are stocks whose earnings are expected to grow at an above average rate relative to the market. Growth stocks don’t usually pay dividends. They prefer to re-invest the company. Generally speaking, one will pay a premium for growth stocks as investors are paying for the future profitability of the company. Growth stock investors don’t mind paying premiums for growing stocks because they believe the increases in earnings will justify the higher valuation.
Growth stocks are more volatile, but produce quicker profit and loss than for example income stocks. It is all about expectations with growth stocks. Growth stocks usually have P/Es of 25 or higher, which reflect those lofty expectations. As long as those expectations are met with earnings the stock will continue to grow and with it your profit potential. Growth stocks usually feature strong growth rates. Lets say you find a company with a PE of 25 and a growth rate of 54%. You may have found a winner here, but these types don’t usually fall into your lap very often. On the other hand lets say you are invested in a growth stock and the company reports less than expected earnings for a quarter. Expected earnings are those that professionals are predicting. One bad report and all you paper profit can be lost or reduced.. Many companies can remain growth stocks for years. Home Depot is a excellent example. I owned several hundred shares of Home Depot in the late 1980’s and it remained a stellar performer for a decade, but all good things come to an end.
On the other hand values stocks function and trade differently than growth stocks. Value stocks are those with low price-earnings ratios and high projected earnings-growth rates. Value investing has proven to be a successful investment strategy. These stocks have usually fallen out of favor for some reason. Perhaps a negative earning report or negative company new about the future outlook for earnings. This doesn’t make these stocks bad investments. Value investors want firms that, although going through a rough period, have a solid history of profitability. As with any commodity, buying at discount to true value is good for the bottom line, in time. Value investors look at value stocks as bargains, like the stock is on sale. Value stocks are often confused for cheap stocks, which they are not. They are undervalued for some reason. A company with a track record for producing profit generally will produce that profit again. When this happens the market, the investors will notice and prices will begin to increase and you will fell all the wiser for spotting this company and buying its shares at a discount when no one else was noticing.