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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 - Get Report) 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 Admiral  (VIGAX - Get Report)   as of Aug. 31, 2019: 

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 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 - Get Report)  as of Aug. 31, 2019: 

VVIAX is a large value index fund 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 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. 

Value Stocks

Growth Stocks

  • Stocks exhibiting slower rates of growth in sales, earnings, cash flow and other metrics than the broad market.
  • Stocks exhibiting higher rates of growth in sales, earnings, cash flow and other metrics than the broad market.
  • Value stocks are generally less risky and less volatile than the broad market.
  • Growth stocks are generally riskier and more volatile than the broad market.
  • Value stocks tend to be focused in slower growth and more mature industries.
  • Growth stocks tend to be focused in growing and rapidly expanding industries.
  • Value stocks generally are undervalued and trade at a level below their true worth, investors hope to profit
  • Growth stocks are expected to outperform the market over time due to their high growth potential.

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' 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 a number of studies on this question and again the results are mixed. There are clearly 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. In fact, 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. There are numerous funds that invest in both growth and value stocks across the full range of market capitalization levels. Additionally, there are funds that do this both for both domestic and international stocks.

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