Choose Your Path Wisely: Growth vs. ValueSeptember 6th, 2018 by Tanner Wrisley
Both growth and value sound like something we want. And it is true, they are both good things to obtain if you are able to. But depending on your financial situation, one might be more closely tied to success in your portfolio than the other.
The difference between these two types of stocks comes from what companies do with their earnings. Companies that put an emphasis on growing their business and expanding their markets, take their earnings and invest back into the business. Amazon is an example of this; they use all company profits to invest in new growth opportunities and widen their operations. This is a textbook example of a growth stock. A company like Coca-Cola uses their earnings very differently. Yes, they will invest some of their earnings back into the company, but the majority will be paid out to the owners. This payment goes out to the shareholders and is called a dividend. Coca-Cola has reached a point where they feel their company will look more attractive to investors if they stop spending on growth, and focus on rewarding those owning shares of their company. This is an example of a value stock.
Growth companies are less proven. Either they are younger, or they are growing and moving into new markets. This generates great potential for growth, but also lots of unknowns for investors. This uncertainty causes these stocks to move up and down more. The volatile nature of growth stocks makes them a target for investors with longer time horizons who can ride out the ups and downs in hopes that the company’s potential comes to fruition. For these investors, success is usually defined by capital appreciation and the size of one’s account balance, and growth stocks are usually the best ticket to get there.
Using earnings to pay shareholders usually takes a large, well-established company, with good financials. These are characteristics that lead to less volatility. Steady value in combination with the dividends, typically make for a good retirement-age investment or someone with a short time horizon. For these investors, success is defined by the consistency of their distributions and the ability of their account to meet their financial needs, so dividend paying value stocks are the best bet here.
Growth and value have characteristics that lend themselves to different types of investors, but it can be useful to have both in a portfolio. In fact many money managers make a point to include both, regardless of your time horizon, as a way of diversifying the portfolio. Whether you invest in growth, value, or both, it is important to understand what kind of stock you are buying because they will behave differently.