We often hear the terms growth stock and value stock. But what are growth and value stocks? What differentiates these two styles?
What Are Growth Stocks?
Growth stocks are those stocks expected to grow faster than the average stock. For example, Morningstar MORN defines growth stocks as those exhibiting fast growth in metrics like sales, earnings, book value, and cash flow. Most of these companies have high valuations such as high price-earnings ratios. They often have low dividend yields. These stocks are often in fast-growing industries.
As an example of some growth stock names, here are the top 10 largest holdings in the Vanguard Growth Index Fund AdmiralVIGAX as of Aug. 31, 2019:
- Microsoft Corporation MSFT
- Apple, Inc. AAPL
- Amazon.com, Inc. AMZN
- Facebook, Inc. A FB
- Alphabet, Inc. A (Google) GOOGL
- Alphabet, Inc. Class C (Google) GOOG
- Visa, Inc. Class A V
- Mastercard, Inc. A MA
- The Home Depot, Inc. HD
- Comcast Corp Class A
As you can see, these are all household names and growing, successful companies.
VIGAX is a large growth index fund that targets companies in the fastest growing and most richly valued half of the U.S. large-cap stock universe.
Growth stocks occur across the range of stocks in both the U.S. and the non-U.S. stock universe. There are U.S. growth stocks in both the mid-cap and small-cap stock categories, as well as across the range of both developed and emerging market non-U.S. stocks.
What Are Value Stocks?
Morningstar defines value stocks as those that are less expensive or that are growing at a slower rate than the average stock. Value stocks generally show slower growth in metrics such as sales, earnings, cash flow, and book value. Their dividend yields are typically higher than the average stock, while their price to earnings ratio is often lower.
As an example of some value stock names, here are the 10 largest holdings in the Vanguard Value Index Fund Admiral VVIAX as of Aug. 31, 2019:
- Berkshire Hathaway, Inc. BRK.A
- Johnson & Johnson JNJ
- JP Morgan Chase & Co. JPM
- Proctor & Gamble Co. PG
- Exxon Mobil Corp. XOM
- AT&T, Inc. T
- Verizon Communications, Inc. VZ
- Bank of America Corporation BAC
- Chevron Corp. CVX
- Merck & Co., Inc.MRK
VVIAX is a large value index fund that tracks an index that targets companies in the cheaper and slower-growing half of the U.S. large-cap stock universe.
Value stocks occur across the range of stocks in both the U.S. and the non-U.S. stock universe. There are U.S. value stocks in both the mid-cap and small-cap stock categories, as well as across the range of both developed and emerging market non-U.S. stocks.
Growth Stocks vs. Value Stocks - Key Differences
Here is a summary of some of the key differences between growth and value stocks.
Pros and Cons of Growth vs. Value Stocks
Both growth and value stocks have their pros and cons.
Growth Stocks - Pros:
- Growth stocks tend to reflect companies with records of higher earnings and faster growth.
- Growth stock companies may pay a dividend, but they tend to reinvest their earnings back into the company reflecting their expectations of continued growth.
Growth Stocks - Cons:
- Growth stocks tend to be more volatile than the broad market. While growth stocks have solid potential when earnings meet or exceed Wall Street's expectations, the market can punish these stocks based on disappointing earnings or other negative news surrounding the company.
Value Stocks - Pros:
- Value stocks generally are priced lower than the average stock in the broad market. Value investing is predicated on the idea that these stocks can be purchased at a lower price with the potential for price growth over time.
- Generally, value stocks carry less risk than the overall market, though their price can fluctuate in the short-term.
Value Stocks - Cons:
- It can be difficult to always identify if a so-called value stock is simply undervalued or if the company's price is low for other reasons.
Which Type of Stock Is Better?
Both growth and value stocks can have a place in an investor's portfolio. The combination of the two types of stocks, across the range of domestic and foreign stocks, as well as across market cap ranges, are the building blocks of the equity portion of a diversified portfolio.
Which type of stock performs better over time? There have been several studies on this question and again the results are mixed. There are periods where growth has outperformed value and vice versa.
If we look at the two funds mentioned above, Vanguard Value Index and Vanguard Growth Index, both funds have an inception date of Nov. 13, 2000. Through Aug. 31, 2019, the average annual return of the Vanguard Growth Index Admiral Shares is 6.41%, the average annual return of Vanguard Value Index Admiral Shares is 6.40%, according to data from Morningstar. Each fund has outperformed the other at various times and over different periods, however.
Investing in growth and value stocks doesn't have to be done by investing in individual stocks. It can be difficult to always tell which stocks are in the growth category and which are value stocks.
For those investors looking to allocate their portfolios between growth and value, mutual funds and ETFs can be an effective tool in these efforts. Numerous funds invest in both growth and value stocks across the full range of market capitalization levels. Additionally, some funds do this both for both domestic and international stocks.