Growth and value are two of the most important factors that govern the process of choosing stocks for investment purposes. The two main types of investing include value investing and growth investing (Scilitani, 2001). Value investors look for companies that are undervalued while growth investors look for companies that have positive projections for high revenues.
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It is important to understand the difference between growth stocks and value stocks before diving into the world of investing in stocks. The main difference between the two types of stocks is the method used to determine their value by evaluating the past and future performance of mother companies. Growth investing is based on a company’s past, while value investing is based on a company’s future (Scilitani, 2001).
Differences between growth and value stocks
One of the most critical factors involved in identifying growth stocks is the expansion rate of a company, as well as its projected increase in revenue. Therefore, growth stocks are associated with companies whose revenues are projected to increase at a rate above the market average (Scilitani, 2001). In many cases, these stocks possess high price-to-earnings ratios.
In addition, they have high price-to-book ratios. The price-to-earnings ratio is computed by dividing the current market value of a share by the share’s earnings in the past year (Scilitani, 2001). On the other hand, the price-to-book ratio refers to the current market value of a stock divided by its current book value.
In open financial markets, high value is usually placed on growth stocks because they are usually more valuable and appealing to investors when compared to value stocks. Growth stocks are identified by looking at the earnings and rates of growth of companies. Harsh economic times affect the earnings of companies. However, growth companies implement strategies that guarantee high earnings despite tough financial times.
In contrast, value stocks refer to stocks whose current market price or valuation does not reflect their real value because they are underpriced (Scilitani, 2001). In addition, they have low price-to-book ratios, and their pricing is low compared to their replacement and liquidation values. Examples include stocks of companies that have low price to earnings ratios and high dividend yields. These stocks generally trade at prices lower than those of related fundamentals, such as earnings and dividends (Scilitani, 2001).
Value investors choose these stocks because many markets ignore their low ratios that fail to reflect the real intrinsic values of different companies. Growth investors consider a company’s financial past, while value investors consider a company’s financial future. The process of investing in value stocks involves the identification of a firm’s intrinsic value by determining its return on equity and the rate of revenue growth.
Value investing is based on the belief that market prices do not accurately represent the true value of a company (Scilitani, 2001). For instance, the stock of a new company could be underpriced because of investors’ lack of confidence in its management. Low pricing of stock could mislead investors because it could have originated from temporary organizational problems that have insignificant effects on a firm’s profitability or revenue.
Both types of stocks play critical roles in financial portfolios because they run in cycles and carry different financial risks. Therefore, including both types in a portfolio helps to manage risk and improve financial returns in the long-term (Scilitani, 2001).
Examples of growth and value stocks
The NASDAQ Stock Market is the largest stock market in the United States. One of the most promising growth stocks in the NASDAQ is Google. Google went public in 2004, and since then, it has experienced rapid growth that has elevated it to one of the largest companies based on market capitalization. Currently, its stock is third in terms of valuation, only lagging behind Apple Inc. and Exxon. The company is projected to occupy the first spot in the future by becoming the largest with regard to market capitalization.
The company’s top-line growth is vigorous, mainly due to its involvement in new markets and innovation. Its annual earnings continue to grow at a rate of more than 20% (Sander & Bobo 2013). This growth is largely due to an increasing rate of its search engine’s use at a rate of approximately 25% every year. The company has ventured into other lucrative businesses such as the delivery of applications and research that are projected to increase its earnings significantly.
The stock trades at approximately 20 times its earnings and experiences a 20% growth rate annually (Sander & Bobo 2013). It has an EPS of 19.08 and a market capitalization of $176billion. An example of a value stock at the NASDAQ is Capital One Financial (COF). As mentioned earlier, a value stock has a low price to earnings ratio. Currently, the stock is trading at a price-to-earnings ratio of 10.8, which is relatively low. The ratio is projected to decrease further.
This decrease is expected to result in significant growth that will hike the price of the stock (Sander & Bobo 2013). The stock has a dividend yield of 1.5% and earnings per share of 7.42. The company’s market capitalization is estimated at $44.57billion. These statistics reveal that the stock is undervalued and a good value stock for investors.
Sander, P., & Bobo, S. (2013). The 100 Best Stocks to Buy in 2014. New York: F+W Media.
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Scilitani, A. (2001). Basic Investing Guide for the New Investor. New York: iUniverse.