It becomes very convenient to invest in the stock market if someone knows the art of stock picking. The stock market never moves in a straight line, and thus, investors have to deploy different strategies for generating returns on investments.
Often, experience investors talk about two different investing styles, among others – Value Investing and Growth Investing.
These two are the best-known approaches in fundamental investing. Each type has its own set of followers with its own logic and analysis to back their claims.
Growth and value investments tend to run in cycles. Companies that have registered better-than-average gains in the market and have the potential to give higher returns are classified as growth stocks.
In simpler terms, growth stocks have a healthy record of earnings and are generally expected to continue with the same in the future as well. Their future growth prospects attract potential investors. But there is always the risk of a sudden drop in a stock price due to negative earnings or bad news about a company.
Value investing encapsulates two primary concepts – namely undervaluation and overvaluation. The idea behind value investing is to buy a stock when it is undervalued or on sale, and sell it when it reaches its true or intrinsic value, or rise above it. Such a stock can be identified by comparing the company’s intrinsic value to current market value. Value investing is considered to carry lesser risks compared with the rest of the market.
Now the question is, which style — growth or value — is likely to give higher returns over the long term? Neither approach is guaranteed to provide appreciation in stock value; both carry investment risks.
We need to understand that basically growth stocks perform better in a falling interest rates environment when corporate earnings keep on rising. But they get badly hit when there is a slowdown in the economy. When economic conditions are good, growth stocks on an average outperform value stocks modestly.
On the contrary, value stocks, which are often from cyclical industries, may do well early into an economic recovery cycle but lag in a sustained bull market.
Therefore, which group one should pick would depend a lot on the specific time, risk tolerance and investment goals of the investor. It is always better to combine growth and value stocks for the potential of high returns with lesser risk. Yes, the best bet is to hold both for true diversification. This approach will allow investors to gain throughout an economic cycle in which the general market situations can favour either growth or value investment styles.