Growth vs. Value: Two Approaches to Stock Selection

Growth and value are two fundamental approaches in stock and stock mutual fund investing. Growth stock mutual fund managers look for companies that they believe offer strong earnings growth potential. Value fund managers look for stocks that appear undervalued by the marketplace. Some managers combine the two approaches.

Growth and Value Defined
Growth stocks are generally those of companies that have delivered better-than-average earnings and are expected to continue growing rapidly. “Emerging” growth stocks are expected to do the same, but the underlying companies are relatively new and have not established an earnings history. Investors are willing to pay higher-than-average prices for growth stocks, hoping to sell these stocks at even higher prices. The risk is that a growth stock’s lofty price could fall sharply on any negative news about the company, particularly if earnings disappoint Wall Street.

Value stocks are generally those of companies that have fallen out of favor in the marketplace and are considered bargain-priced compared with potential long-term value. Typically, value stocks are priced much lower than stocks of similar companies. This lower price may reflect investor reaction to recent company problems, such as disappointing earnings, negative publicity, or legal issues. Value stocks may also include new companies that haven been noticed by the marketplace. The idea is that stocks of good underpriced companies will bounce back when their true value is recognized. But this may take time and, in some cases, may never materialize.

The primary measures used to define growth and value stocks are the price-to-earnings ratio (P/E) — the market price of a stock divided by the earnings per share — and the price-to-book ratio (P/B) — the share price divided by the net asset value per share. Growth stocks usually have high P/E and P/B ratios. In contrast, value stocks typically have relatively low P/E and P/B ratios.

Two Styles That May Work Well Together
For many investors, there may not be an absolute advantage to any single approach. Instead, they may strive for the best-possible returns with minimum risk by combining growth and value investing. This approach allows investors to potentially gain throughout economic cycles in which general market situations favor either growth or value stocks.

To learn more about growth and value investments, ask a qualified financial professional. He or she can tell you about your options, including mutual funds that invest with a growth or value approach.

©2004 Standard & Poor’s Financial Communications. All rights reserved.