Growth Stocks vs. Value Stocks: Understanding the Difference

In this article, we will talk about the key features and differences between growth stocks vs value stocks.

Definition

Growth stocks are stocks that come with a substantially higher growth rate compared to the mean growth rate prevailing in the market. It means that the stock grows at a faster rate than the average stock in the market, consequently generating earnings at a faster rate.

Value stocks are stocks that are being traded at a value lower than their intrinsic valueIntrinsic ValueThe intrinsic value of a business (or any investment security) is the present value of all expected future cash flows, discounted at the appropriate discount rate. Unlike relative forms of valuation that look at comparable companies, intrinsic valuation looks only at the inherent value of a business on its own.. It basically means that such stocks are undervalued. Undervalued stocks are traded at a price lower than their true value.

Pricing

Growth stocks are often relatively correctly valued or sometimes even overvalued, because of their significantly high growth rate. Hence, they are higher priced in the market. The act of investing in growth stocks is known as growth investingStock Investing: A Guide to Growth InvestingInvestors can take advantage of new growth investing strategies in order to more precisely hone in on stocks or other investments offering above-average growth potential., i.e., investing in stocks that experience continued growth.

Value stocks are undervalued stocks that have the potential to grow and generate returns in the future substantially. Hence, they are priced much lower than similar stocks in the market. The act of investing in value stocks is known as value investingStock Investing: A Guide to Value InvestingSince the publication of "The Intelligent Investor" by Ben Graham, what is commonly known as "value investing" has become one of the most widely respected and widely followed methods of stock picking., i.e., investing in stocks that are undervalued but with the potential to generate revenues when the market corrects its price.

Investment Metric Ratios and Risk

Growth stocks come with higher metric ratios, like P/E ratioPrice Earnings RatioThe Price Earnings Ratio (P/E Ratio is the relationship between a company’s stock price and earnings per share. It provides a better sense of the value of a company., P/B ratio, and earnings per share (EPS)Earnings Per Share (EPS)Earnings per share (EPS) is a key metric used to determine the common shareholder's portion of the company’s profit. EPS measures each common share's profit. Growth stocks carry relatively lesser risk because their growth rate is high and increasing. They are relatively less sensitive to adverse economic conditions than the overall market. Hence, growth stocks are relatively less risky investments.

Value stocks come with lower metric ratios because they are undervalued. Value stocks are expected to gain value eventually when the market corrects their prices. In the unlikely event that the stock doesn’t appreciate in value as was expected, investors can lose their money. Hence, value stocks are relatively riskier investments.

Business Profile and Dividends

Growth stocks are usually up-and-coming companies. Such companies usually introduce something new and innovative to the market and are growing increasingly, owing to their unique selling proposition (USP) and competitive advantage.

Growth stocks usually pay very little or no dividends at all. It is because such companies usually follow a reinvestment protocol wherein they reinvest all their retained earnings back into the company.

Value stocks are usually large, well-established companies that are undervalued for a variety of reasons, such as negative PR, a bad earnings season, and so on, but eventually gain back value in the long term. Value stocks usually pay dividends well and don’t reinvest the entirety of their retained earnings back into the company.

More Resources

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