The two basic investing styles are growth and value. While one style tends to perform better at any given time, the dominant style varies over time. The basic elements of each style include:
Growth Investing
Growth investors look for stocks with above-average growth in sales and earnings, typically at a 15% or higher annual rate. These are typically stocks of younger companies in a rapid growth stage of development, although larger companies can also qualify as growth companies. Growth companies tend to have higher price/earnings ratios with little or no dividends, since earnings are typically used to finance future growth. As growth stocks gain favor, investors tend to bid their prices up to lofty levels. Thus, the price/earnings (P/E) ratios of growth companies can be two or three times higher than the overall market. Earnings projections largely drive the value of these companies, so earnings disappointments can dramatically impact their value.
When searching for appropriate growth stocks, you should be looking for a fast-growing company that you feel will be able to sustain that growth for an extended period of time.
Value Investing
Value investors emphasize stocks with market earnings that are low based on earnings, dividends, or assets. Companies in this category typically include those in out-of-favor industries, turnaround or troubled companies, or mature and stable companies with modest growth expectations. Dividend yield may be higher than average since the stock price is low. Signals that a company may be turning around include insider buying, improving profit margins, increasing earnings estimates, or higher trading volumes. Value investors must typically exhibit patience, since it can take a while for the market to realize a particular stock's value.
When searching for value stocks, you should look for a company with depressed earnings and a stock price that you feel will recover soon.
Which Style Performs Better?
Growth stocks typically do well when the economy is growing and the stock market is rising, while value stocks typically do well when the stock market is peaking or falling. Many investors are naturally drawn to a growth investing style since growth stocks usually have exciting news, capturing much press attention. Value companies often receive unfavorable press, requiring more resolve on the investor's part to continue holding them.
So which style will excel in the future? Just as you can't predict where the market is headed, it is difficult to determine when each style will dominate. Thus, it may make more sense to include both styles in your portfolio. That way, no matter what style dominates, it will be represented in your portfolio.
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Growth investing does not guarantee a profit or eliminate risk. The stocks of these companies can have relatively high valuations. Because of these high valuations, an investment in a growth stock can be more risky than an investment in a company with more modest growth expectations. Value investing involves the risk that the market may not recognize that securities are undervalued, and they may not appreciate as expected.