Building an investment portfolio for the long term means finding a strategy that will work in both the best of times and the worst of times. And with so many investment styles to choose from, it pays to understand the basics. One of the most fundamental characteristics of a stock is whether it favors growth or value. Growth and value investments exist within many market spaces, including domestic and international stocks, and they represent all company sizes, from small-cap to mega-cap. Both styles have many proponents, and both are represented by numerous mutual funds and ETFs. But an ongoing debate about whether one style outperforms the other may leave some investors wondering what the difference is, and how it might affect their portfolios in the short and long term.
By definition, growth firms have earnings that are growing at, or are expected to grow at, an above-average rate relative to the market. In a recent interview, Robert Bartolo, a growth manager with T. Rowe Price, outlines the qualities that he’s looked for when selecting growth stocks. These include companies with large target markets and those that offer a sustainable competitive advantage. He also looks for earnings growth of at least 10% per year.
Investors in growth stocks generally don’t seek out dividends. They prefer companies that reinvest any profits in the business rather than pay them out to shareholders. Many people commonly associate the technology sector with growth because of the high level of innovation found there.
Value investors, on the other hand, seek out companies whose shares may be underpriced by the market relative to their peers. Some value investments may include companies that have fallen out of favor in the market for any number of reasons. It’s necessary to look at the fundamental metrics of such stocks. One of those metrics is the price-to-earnings (P/E) ratio, which measures a stock’s value by comparing its price relative to its earnings. Growth stocks will typically have much higher P/E ratios than value stocks because investors are paying for a faster expected earnings growth rate. Other traits of a value investment could include a low price-to-book ratio and/or a high dividend yield.
The pioneer of value investing is Benjamin Graham, and Warren Buffett is likely its most renowned practitioner. Graham famously encouraged investors to seek out a margin of safety to protect themselves from future developments that could negatively affect the trading prices of their stocks. Similarly, Buffett strongly advocates looking at a company’s past as the primary indicator of what it may do in the future. He maintains that the future is full of unknowns and that overpaying for today’s earnings can erode an investor’s margin of safety. Buffett famously avoided allocating into technology stocks during the early 2000s, when technology stock valuations were rising rapidly. Instead, he kept to his value-oriented investing principles, and his funds weathered the tech bubble quite well, while those who shifted their portfolios heavily into technology may have gotten burned.
Which to Choose?
So which style of investing is better? There is certainly no definitive answer to that because what is appropriate for one investor may not be appropriate for another. Financial Advisor Magazine recently analyzed growth vs. value investments by looking at performance statistics in a few different ways. The article notes that growth often wins in strong bull markets, such as the one we’ve been in since the beginning of 2009. According to the article, growth outperformed value by 4% per year from the end of 2008 through early 2015. However, their data found that value has outperformed growth over the longer term, and has done so with less volatility. An article from CBS News, which includes research from Eugene Fama and Kenneth French, also concludes that value investing has outperformed growth in the long run, and has done so domestically and internationally.
Further complicating matters, market valuations have climbed dramatically over the past few years, blurring the lines between growth and value. The process of finding bargains in the market has become increasingly difficult. Many investors may not choose to focus on one investing style over the other.
Fortunately, both growth and value stocks have a long history of positive returns. And investors can tap the potential of both approaches through a diversified portfolio that includes both growth and value investments, in a proportion that’s appropriate for their own individual goals and risk tolerances. Diversifying across investment styles—as well as across securities, industries, and sectors—is a far, far better way to invest than betting everything on any single approach.
 Rotblut, Charles. Interview with Robert Bartolo, “Traits to Look for in Growth Stocks,” http://www.aaii.com/journal/article/traits-to-look-for-in-growth-stocks.pdf
 Bresiger, Gregory, “Which Wins - Value Or Growth Investing?” March 25, 2015. http://www.fa-mag.com/news/which-wins---value-or-growth-investing-17354.html
 Long, Heather, “Bull market is 3rd longest in U.S. history.” May 6, 2015. http://money.cnn.com/2015/05/06/investing/stocks-market-3rd-longest-us-bull-market/
 Swedroe, Larry, “Do Value Stocks Outperform Growth Stocks,” March 28, 2012. http://www.cbsnews.com/news/do-value-stocks-outperform-growth-stocks/
 Strauss, Lawrence C., “When Growth Mirrors Value,” February 13, 2015. http://online.barrons.com/articles/SB51367578116875004693704580451810260784310