Growth vs. Value Investing: Which is Better?

What Is Growth Investing?

Growth investing is a strategy that focuses on companies with revenue or earnings that are expected to grow faster than the overall market. Instead of looking for companies that appear cheap, growth investors look for companies with high growth potential.

Investors may be willing to pay a higher share price because they believe the company operates in a fast-growing industry or is developing products or services that could significantly increase future earnings.

Growth companies often reinvest their earnings into activities that help expand the business rather than paying high dividends. These investments may include:

• Developing new technology
• Launching new products or services
• Expanding into new markets
• Hiring additional talent
• Scaling operations

Even when growth companies do pay dividends, investors typically focus on long-term share price appreciation rather than income. However, growth expectations aren't guaranteed. If a company fails to meet growth projections, its stock price may fall.

Growth stocks can also be more volatile than other investments. Prices may rise quickly when the company shares good news or reports positive earnings, but they may also decline rapidly if growth slows or expectations change.

Over time, companies may transition out of the growth category as their expansion stabilities and earnings growth slows.

Types of Growth Investments

There are three main types of growth investments.

• Growth funds: Mutual funds or exchange-traded funds (ETFs) that are heavily invested in growth companies. Some funds are actively managed, while others track growth-focused market indexes.
• Growth stocks: These are stocks of companies expected to achieve above-average earnings and revenue growth. Many companies reinvest profits into expansion instead of paying dividends.
• Small-cap and mid-cap stocks: Companies with smaller market capitalizations may still be in their initial phases of growth and have more room to grow than larger, more established companies.

Pros and Cons of Growth Investing

Growth investing offers an opportunity for big profits, but requires a high risk tolerance. Understanding the pros and cons can help you determine whether this strategy is a good fit.

What Is Value Investing?

Value investing focuses on finding companies whose stocks appear to be underpriced relative to the company's fundamentals—earnings, cash flow and other financial metrics. Value investors look to purchase shares at a discount and potentially profit when the price rises to reflect the company's actual worth.

Value investors don't necessarily focus on cheap shares. Instead, they look for opportunities to buy shares at a price that's lower than the company's estimated value. These opportunities can happen for several reasons, including:

• Negative press
• Market overreactions
• Short-term setbacks
• Economic downturns

While value stocks may carry less volatility, they can still experience short-term market fluctuations. It may take time for the market to recognize the company's value and raise the stock price. For this reason, investors often have a longer time horizon.

Some value stocks pay dividends, which can provide additional income for investors. However, dividends aren't a requirement for a value investment.

Types of Value Investments

Common types of value investments include:

• Value stocks: These are individual stocks that appear to trade below their value based on financial metrics.
• Value funds: Mutual funds or ETFs that are heavily invested in value companies.

Pros and Cons of Value Investing

Value investing involves buying stocks that are undervalued compared to the broader market and selling for a profit if and when the price rises. While there are advantages to value investing, there are also risks to consider.

Value vs. Growth Stocks

Growth investors typically purchase companies that are expected to grow faster than their industry or the overall market. By comparison, value investors look for companies whose stock appears undervalued compared with their fundamentals. Value investors aim to purchase stocks at a discount and later profit when the stock price rises.

Growth stocks tend to perform better in bull markets and periods of lower interest rates, when companies can access low-cost financing to fuel their growth. Value stocks may perform better during market downturns, when investors prioritize stability.

Because growth stocks are volatile, investors often hold on to them for a long time to allow the company to realize its growth potential (though this result is not guaranteed). Value investors may also hold investments long enough for the market to recognize the company's value.

Learn more: What Are the Different Types of Stocks?

Should I Invest in Growth or Value Stocks?

Whether to invest in growth or value stocks depends on several factors, including market conditions as well as your risk tolerance, time horizon and investment goals.

When to Invest in Growth Stocks

Growth investors typically look for exposure to companies that may expand rapidly. Investing in growth stocks may be more appealing when:

• The economy is expanding. Growth stocks perform better when there's consumer spending and business investment are increasing.
• Interest rates are low. Lower borrowing costs can make it easier for companies to invest in expansion.
• You have a long investment horizon. Growth companies can experience significant volatility in the short term, but long-term investors have time for their investment to recover.
• Your risk tolerance is high. You're comfortable with large price fluctuations in exchange for the possibility of higher returns.

When to Invest in Value Stocks

Value investors look to buy stocks that are trading below their worth. Investing in value stocks might make sense when:

• There's a market downturn. Overall market fear can temporarily push stock prices lower, even for fundamentally strong companies.
• An industry is temporarily out of favor. Sometimes sectors fall due to economic or market conditions. For example, energy stocks when oil prices drop or banking stocks when there are recession fears.
• A company is having short-term problems. Strong companies may have temporary challenges when there's negative news coverage, lower-than-expected earnings or leadership changes.
• You prefer slow, steady growth or cash flow. It can take time for the market to recognize a company's true value and adjust the price. In the meantime, dividends can provide steady income.

Tip: You can balance the two strategies by diversifying your portfolio with a mix of both types of investments. Over time, you might adjust your portfolio mix based on market conditions, your current financial goals and your portfolio performance.

The Bottom Line

There's no single approach that works for everyone. Ultimately, your investment strategy may borrow from both growth and value investing to manage risk and meet your long-term investment goals. If you're stuck, consider consulting with a financial advisor to assess your goals and create a personalized investment strategy.