As an investor, it’s important to keep in mind that there’s more than one smart way to make money in the stock market. At Wela, we're big on income investing, but when searching for an investment strategy, it's best to be informed of the potential risks of and differences between each approach. Here we will focus on growth and value investing, two essential processes to recognize in stock investing. Both of these market strategies seek to provide the best possible returns, so the real difference between the two is in their approach.
An investor looking to commit a portion of a portfolio for a very long term should look into growth investing. These investments won’t give quick returns, but when they do pay off, it can be well worth the wait. Growth stocks are shares in companies with strong momentum, using every resource to expand their product or service to generate more revenue and dominate that particular market. Investors buy these stocks with the expectation they will steadily increase in price and net a tidy profit when sold.
Two current examples of these stocks are Amazon and Netflix. Both companies prioritize technological advancement and infrastructure expansion over profit to dominate their categories. Their success has driven the value of their shares upward over the past two decades. These businesses can see higher price-to-earnings ratios and price-to-book ratios which indicate the market's certainty in a company's ability to continue increasing profits.
While growth stocks have the potential to offer higher returns, when compared to value stocks, they tend to have more volatility. The risk is a sudden price drop in the stock due to negative earnings or bad news about the company. So remember, volatility is part of the growth game — higher potential upside comes with higher risk of downside, but wild swings are part of the ride.
Value investments are defined as companies whose stock prices do not necessarily reflect their worth. Value investors actively hunt for shares they believe are undervalued by the market but still have a strong potential upside. These stocks are analyzed by comparing the company’s intrinsic value to its current market value. A businesses’ intrinsic value is determined by evaluating the fundamental aspect of the company including its business model, management, financial statements and competitive situation. When a company’s intrinsic value is higher than its current market value, the stock is considered a value.
In early 2016, Fitbit released a quarterly report showing a 50% year-to-year increase in revenues and a prediction of continued revenue growth in 2016. However, because the company had invested heavily in R&D, earnings per share dropped on a year-to-year basis. It resulted in a 19% drop in Fitbit’s stock price, which created the perfect opportunity for value investors to buy a strong value stock at a considerable discount.
To repeat, growth investors must keep in mind that these stocks should be part of a long-term strategy. When buying your shares, choose companies with products or services you believe in and stick with them when the market swings. Buying and selling these stocks based on downturns in the market will cost you money in either actual losses or profits from future appreciation of the stock. As with any investment and before you buy any stock, be sure to research all aspects of the company to make smarter investment decisions for your portfolio.