Good investment management is about looking after your money and will involve finding the investment style to suit your character and risk tolerance as well as your overarching retirement financial goals.
One aspect of this process is finding the right balance of growth stocks v value stocks for your portfolio. But what are growth stocks and what are value stocks. Below we take a look at the differences between the two and their relevance to successful investment management.
Growth stocks tend to be offered by established companies offering earnings higher than the average market rate – i.e. they have a high price-to-earnings (P/E) ratio and high price-to-book ratios. To qualify as a growth stock, analysts assert that it should achieve a 15 percent or higher return on equity. Because growth stocks are usually recognised as offering high value, they may come at a premium.
Furthermore, investors in growth stocks are less likely to receive money from dividends than they are from future capital appreciation. For some, this can be a drawback, and for others a plus. Certain investors may see growth stocks as representing poor value in the market, particularly in relation to value stocks; others will overlook this in favour of the potential that growth stocks have to outperform the overall market over the longer term.
Value stocks are those that market analysts mark as having a trading value below their book value. There are many reasons why a stock might be undervalued. For example, it might have attracted negative headlines because of a recent news scandal or because of some other form of market volatility. Investors in value stocks buy them in the hope that they will rise in value as the market adjusts to reflect their true worth. However, just as overweighting investment in growth stocks may prove risky, so too may investing heavily in value stocks.
Which is the right approach?
Quite simply, whether an investor chooses to place greater emphasis on growth or value stocks depends on their individual time horizon, goals, risk tolerance and financial advice.
It is also important to realise that over shorter investment cycles, the performance of either growth or value stocks depends largely on the particular conditions of the market. For example, value stocks usually fair better during bear markets, while growth stocks may perform better during bull markets. In all likelihood, the way to increase the chances of growth over the long-term is to invest in a diversified portfolio that includes a broad mix of both categories.
So called “blended funds” offer a combination of the two stock types and some portfolio managers will adopt a GARP strategy (growth at a reasonable price) which actively identifies growth companies but also considers the indicators of value.