Value vs. Growth Investing
The best indicator of a stock's value is its price. The price is the market's way of assessing risk, which determines a stock's expected rate of return. In other words, the prices people pay for stocks are the prices that will produce the expected returns they require in order to hold the stocks.
The terms "growth" and "value" are often used without completely understanding what these terms really mean or how these types of stocks influence the overall risk and return of a portfolio. News affects the prices of all companies including firms in sound financial condition with stable earnings, as well as firms suffering from some type of distress. Whatever the nature of the company, the price invariably reflects the market's perception of its financial health which is often described by the terms "growth" or "value." Whether you should invest in a growth or value stock depends on your own risk tolerance, investment time horizon and circumstances.
Typically, a growth stock represents a company which has a history of increasing its revenues more quickly than other companies. Growth stocks are usually expensive and have lower rates of return than value stocks. Value stocks are priced inexpensively because they have poorer prospects than growth stocks. Historically, these distressed stocks have, as an asset class, provided higher rates of return than have growth stocks.
The stock market requires distressed companies to discount their stock price to a level that provides an acceptable return to compensate investors who choose to take on more risk. Risk determines return, so the investor's goal is to maximize the return on an investment for any given level of assumed risk. Investing in a portfolio of extremely distressed companies may be an excellent investment for an individual who can bear the risk.
A portfolio of stocks designed to simply capture the returns of the overall stock market is easy to purchase (via index funds) and provides significant advantages. Common stocks provide protection against price inflation, as well as the potential to provide growth in real terms. Stocks contribute to overall portfolio stability because they are not strongly correlated to the returns of other asset classes such as cash, short-term bonds, income generating assets, and gold related assets.
In 1992, stock market researchers Eugene Fama and Kenneth French demonstrated that investors can improve upon a simple portfolio designed to replicate the entire U.S. stock market. They concluded that the growth and value effect existed across both U.S. large and small cap stocks, as well as foreign stocks. Thus an investor can consider several categories of stocks as potential building blocks with which they can construct a portfolio suited to his or her own taste. An aggressive investor could thus "weight" his portfolio more heavily toward small cap value stocks, even extending to foreign stocks, in order to accept more market risk in exchange for higher potential returns.
From this perspective it might seem unusual that an investor would allocate any funds to growth stocks, which have lower expected returns. However, many investors have lower tolerance for the risk that at any point in time their returns might not be in line with those of the overall stock market. Despite strong evidence that value stocks provide higher expected returns over time, there have clearly been periods over the short-term when growth stocks have outperformed value stocks, such as in the late 1990s.
What is the best way to buy stocks?... The next time you are tempted to look over your shoulder at a hot stock pick, ask yourself this question: "Does this stock fit my investment profile?"... This question should remind you to make your investment decisions in the proper context of your risk tolerance and goals. "Value" and "growth" are both appealing labels that suggest an opportunity or a bargain, but in reality they only describe levels of risk. Promises of easy money are tempting but the market in fact offers no free lunches!
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Member Erik Berg sends news of a web site where you can listen in to discussions about various investment topics and here it is for your further interest.
http://www.soundinvesting.com/listen.html
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The terms "growth" and "value" are often used without completely understanding what these terms really mean or how these types of stocks influence the overall risk and return of a portfolio. News affects the prices of all companies including firms in sound financial condition with stable earnings, as well as firms suffering from some type of distress. Whatever the nature of the company, the price invariably reflects the market's perception of its financial health which is often described by the terms "growth" or "value." Whether you should invest in a growth or value stock depends on your own risk tolerance, investment time horizon and circumstances.
Typically, a growth stock represents a company which has a history of increasing its revenues more quickly than other companies. Growth stocks are usually expensive and have lower rates of return than value stocks. Value stocks are priced inexpensively because they have poorer prospects than growth stocks. Historically, these distressed stocks have, as an asset class, provided higher rates of return than have growth stocks.
The stock market requires distressed companies to discount their stock price to a level that provides an acceptable return to compensate investors who choose to take on more risk. Risk determines return, so the investor's goal is to maximize the return on an investment for any given level of assumed risk. Investing in a portfolio of extremely distressed companies may be an excellent investment for an individual who can bear the risk.
A portfolio of stocks designed to simply capture the returns of the overall stock market is easy to purchase (via index funds) and provides significant advantages. Common stocks provide protection against price inflation, as well as the potential to provide growth in real terms. Stocks contribute to overall portfolio stability because they are not strongly correlated to the returns of other asset classes such as cash, short-term bonds, income generating assets, and gold related assets.
In 1992, stock market researchers Eugene Fama and Kenneth French demonstrated that investors can improve upon a simple portfolio designed to replicate the entire U.S. stock market. They concluded that the growth and value effect existed across both U.S. large and small cap stocks, as well as foreign stocks. Thus an investor can consider several categories of stocks as potential building blocks with which they can construct a portfolio suited to his or her own taste. An aggressive investor could thus "weight" his portfolio more heavily toward small cap value stocks, even extending to foreign stocks, in order to accept more market risk in exchange for higher potential returns.
From this perspective it might seem unusual that an investor would allocate any funds to growth stocks, which have lower expected returns. However, many investors have lower tolerance for the risk that at any point in time their returns might not be in line with those of the overall stock market. Despite strong evidence that value stocks provide higher expected returns over time, there have clearly been periods over the short-term when growth stocks have outperformed value stocks, such as in the late 1990s.
What is the best way to buy stocks?... The next time you are tempted to look over your shoulder at a hot stock pick, ask yourself this question: "Does this stock fit my investment profile?"... This question should remind you to make your investment decisions in the proper context of your risk tolerance and goals. "Value" and "growth" are both appealing labels that suggest an opportunity or a bargain, but in reality they only describe levels of risk. Promises of easy money are tempting but the market in fact offers no free lunches!
------------------------------------------------
Member Erik Berg sends news of a web site where you can listen in to discussions about various investment topics and here it is for your further interest.
http://www.soundinvesting.com/listen.html
------------------------------------------------
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posted by Bob Moser at
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