Two fundamental approaches to investing include buying stock in value- or growth-oriented companies.
Growth-oriented companies place a strong emphasis on the future and growing revenue. They are exciting and fast moving, but you pay a premium for the expectation that the stock will grow faster than the market. Most growth stocks fall in industries in the early stages of their life cycle and they rarely pay dividends. Technology firms commonly fall into the growth category.
Value-oriented companies are generally in well-established industries with predictable business models and stable earnings. Value stocks are sold at a discount to their intrinsic value with an assumption the price will eventually increase to market levels. Value stocks tend to be less volatile and frequently pay dividends. They may sell at a discount because the industry is out of favor or late in its life cycle. Over the last decade, stock in the financial and energy sectors were good examples of value stocks due to low oil prices and low interest rates.
Value stocks are good for patient, resilient investors with a long-time horizon who are willing to wait for the price of the stock to return to its true value. Value stock is best for investors who want the certainty of current profits and dividend payments vs. the promise of future profits.
The category of a company may change back and forth from value to growth depending on economic conditions, financial performance and product life cycles.
There is no clear answer on which style is better; it depends on your preference, investment goals and the economic cycle. A study conducted by the Bank of America looking at stock returns from 1926 through 2015 found growth stocks earned an average annual return of 12.6% while value stocks earned an average annual return of 17%. However, in the 10 years ending July 2019, value stocks only returned 12.9% annually compared to 16.3% for growth stock. Furthermore, value stocks have taken a significant beating so far in 2020.
The recent strength in growth stocks has led many investors to abandon value stocks in search of higher returns. However, historical data indicates maintaining a balanced portfolio including value and growth stock is still advisable. Historically, value stocks tend to underperform in a bear market and outperform in the early stages of recovery. This has happened in almost every economic cycle. Value stocks usually outperform growth in the 12 months following a drop in the economy.
Additionally, value stocks are cheaper than they have ever been in comparison to growth stocks. This is considered unsustainable by many industry experts. Investors place too much emphasis on the short-term, which exaggerates the challenges companies are experiencing and pulls stock prices down significantly below where they should be.
As we start recovering from the COVID-19 bear market, the future should look a little brighter for value stocks. Stay the course and maintain a diversified portfolio, including value stock.
Jane Young is a fee-only certified financial planner. She can be reached at firstname.lastname@example.org.