GROWTH AND VALUE STOCKS -
THE DIFFERENCES

In this article, we will look at growth and value stocks, the key differences between them, and how the strategies can overlap to help investors build a strong portfolio.

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Growth and value stocks represent two fundamental approaches to equity investing, each with distinct characteristics and risks. Understanding these differences can help investors make more informed decisions about which approach might align with their investment goals and risk tolerance.

What Are Growth and Value Stocks?

Growth stocks and value stocks are shares in publicly listed companies which represent different types of investment prospects.  The potential opportunities and risk factors involved for both types of stock are based on the companies they represent having different characteristics.

What are growth stocks?

Growth stocks belong to companies expected to grow their business at an above-average rate compared to their sector or the broader market. The forms in which this growth can be represented and measured include:

• Revenues – Total sales before expenses are deducted.
• Earnings – Net income after costs and taxes are applied.
• Market share – The percentage of total sales or revenue a company generates within a specific industry.

Growth companies typically operate in innovative or rapidly expanding sectors such as technology, biotech, or clean energy. 

When analysing them, growth investors focus less on current valuation metrics and more on future growth potential, with the expectation that earnings growth will eventually justify higher valuations today.

Potential investors should also be aware of two other commonly held features of growth stocks. Knowing these can help identify stocks which fall into the “growth” category, and prepare investors for what might be involved in growth investing strategies:

• Growth stocks are known for having higher-than-average price volatility.
• Since corporate profits are usually reinvested, investors receive little or no dividends, relying solely on share price appreciation for investment returns.

What are value stocks?

Value stocks are companies that the market may be underestimating – their current share price appears low relative to fundamental analysis measures.

Value investing involves conducting fundamental analysis research and studying:

• Macroeconomic factors to determine the underlying prospects of a firm within the business cycle.
• The intrinsic value of a company.
• Potential for investment returns in the form of both dividends and capital appreciation.

A value stock will typically be less volatile than a growth stock. Value stocks often belong to more established companies in mature industries, and many pay regular dividends to shareholders. 

Market conditions, sector norms, individual company circumstances and investor perception all play a role in how stocks are classified. It is possible for two investors to draw differing conclusions on whether a stock is a growth stock or value stock, and for those conclusions to change over time.

How growth and value stocks are commonly classified

Analysts and investors use various indicators to classify stocks as growth or value-oriented, though these classifications can differ based on methodology and time horizon. Some of the commonly used metrics are outlined in the table below.

Indicator	What it can suggest	Key limitation
P/E ratio	Higher ratios often indicate growth expectations; lower ratios may suggest value	Limited use for analysing loss-making companies
Revenue growth expectations	Higher forecasts typically associated with growth stocks	Forecasts can prove inaccurate
Dividend yield	Higher yields often found in value stocks	Some growth companies also pay dividends
Business maturity	Established firms often classified as value	Mature companies can still achieve high growth

The P/E ratio is often used as a valuation tool for both growth and value stocks. It can be used to filter the two types of stock by using the following approach:

• A high P/E ratio suggests that other investors are already committing to the possibility that a firm’s revenues will rise in the future – a feature of growth stocks.
• Value stocks typically display lower P/E ratios, suggesting the market may be undervaluing their current operations.
• While remembering that the effectiveness of this metric is limited when analysing firms that are still operating at a loss or have negative revenues.

As well as comparing the P/E ratio of growth and value stocks against each other, investors can also compare stock P/E ratios to those of industry benchmarks, such as stock indices.

Growth or Value — Which is the Best Strategy?

Growth and value are investing strategies that can complement each other and add diversity to a portfolio; one is not ultimately better than the other.

The choice of which approach to adopt is often influenced by market conditions, risk tolerance, and investment time horizon. 

Market conditions

Past performance is not an indication of future results, but historical data suggests that periods of market rotation can favour one approach over the other:

• During periods of low interest rates and economic expansion, growth stocks have historically performed well as investors are willing to pay premiums for future earnings potential. 
• Conversely, value stocks have often outperformed during periods of higher interest rates or economic uncertainty, when investors seek companies with strong current fundamentals.

Risk tolerance

The price volatility of growth stocks can be considerably higher than that of value stocks. Significant and dramatic changes to profit and loss figures can cause investors to make panic decisions which undermine the viability of their long-term strategy.

Investment time horizon

An investor’s stock choice should consider the date they want their portfolio to mature and reach its optimal valuation. That will influence the types of assets to be included, with analysis of growth and value stocks needing to consider that:

• Growth stocks can underperform during economic slowdowns or in rising-rate environments when future cash flows are discounted more heavily.
• Value stocks can remain undervalued for extended periods, especially if momentum-driven investing dominates.

Investors adopting a buy-and-hold approach, and who have longer time horizons, have more time to navigate the intermittent falls in value of growth stocks – and to hope they recover. They can also allow time for the share prices of undervalued stocks to rise as the market gradually appreciates their true worth.

Final thoughts

Understanding the characteristics and risks of growth and value stocks enables investors to make more informed decisions aligned with their financial goals. It is important to remember that neither approach guarantees success, and that the distinction between the two is not always clear-cut.

Each investor will have their preferred approach, but embracing the difference between growth and value stocks, and considering investing in both, could help to manage risk and potentially optimise returns.

Visit the eToro Academy to learn more about stock valuation techniques.

FAQs

Can a stock be both growth and value?

Yes, stocks can exhibit characteristics of both categories. A company’s management team might adopt a new business plan and external factors such as changing consumer trends can also cause perceptions of stocks to change. A stock may be categorised as a growth stock by one investor, and a value stock by another and those statuses can also change over time.

What does “intrinsic value” mean in simple terms?

Intrinsic value is the real worth of the business, as opposed to its current market price. The intrinsic value of the business will be all those discounted cash flows of the business produced in its lifetime.

What is a “value trap”?

A value trap occurs when a stock appears cheap based on valuation metrics but continues declining due to fundamental business problems. Not all undervalued stocks bounce back and even if they do, the process can take a long time.

Why do growth stocks often look more volatile?

A lot of the variables which go into growth stock valuation analysis are based on future projections rather than current circumstances. That makes growth stock share prices more sensitive to earnings misses, interest rate hikes, or shifts in investor sentiment, which could have ramifications for the business in the future. 

Are growth stocks or value stocks a better investment?

Growth and value are investing strategies that can complement each other and add diversity to a portfolio; one is not ultimately better than the other. The choice depends on individual circumstances and market conditions.