Growth and value investing have long been competing strategies. Investors seeking short-term profits seem to favor growth stocks, while value stocks have a slight advantage in the long term (which refers to a time period of approximately five to 20 years). Growth stocks tend to be more well-known companies, while value stocks have proven to be less popular. The returns generated from these two groups of stocks can also vary depending on a number of circumstances.
Value stocks are companies whose market value, or stock price, is considered cheap in relation to the earnings potential of the business. Investors seek to buy shares of value stocks when they are low in hopes of sharing in future profits with the company over time. Growth stock prices already reflect expanding profits and therefore are more expensive than value stocks. Growth investors are willing to pay a higher price for stocks because they believe that earnings momentum will continue and that they will not have to wait for profits.
In the 43-year period beginning in 1968, the least expensive 10 percent of U.S. value stocks, which were determined based on future projected earnings performance, produced annual returns that were nearly 10 percent better than the most pricey 10 percent of growth stocks, according to a 2011 "Wall Street Journal" article. In evaluating growth and value stocks more broadly in the five-year period leading up to 2011, however, growth stocks' returns were better, as this group advanced nearly 4 percent compared with a 1.5-percent decline in value stocks.
Value and growth stocks can be viewed in light of a company's market capitalization, which is a way to illustrate a company's size. Small-cap value stocks, which have a market capitalization of less than $1.6 billion, beat small-cap growth stocks over the long term. Small-cap value stocks and small-cap growth stocks produced returns of nearly 14 percent and 9 percent, respectively, according to a 2012 "Forbes" article. Large-cap value stocks, which have a market cap of more than $8 billion, similarly beat their growth counterparts over the long term. Large-cap value returns were nearly 11 percent compared with less than 9 percent for large-cap growth stocks.
Emotions and History
Growth stocks have already attained a high price, but when investors become greedy, they begin to believe that the growth will continue indefinitely. Fear prevents investors from value investing because individuals lose hope that stock prices will ever reflect the potential that a company has. Over history, value stock returns exceeded profits earned from growth stocks. In the eight-decade period beginning in 1927, large-cap value stocks earned yearly returns of just below 12 percent versus annual profits of slightly more than 9 percent for large-cap growth stocks, according to a 2009 ABC News article.
Geri Terzo is a business writer with more than 15 years of experience on Wall Street. Throughout her career, she has contributed to the two major cable business networks in segment production and chief-booking capacities and has reported for several major trade publications including "IDD Magazine," "Infrastructure Investor" and MandateWire of the "Financial Times." She works as a journalist who has contributed to The Motley Fool and InvestorPlace. Terzo is a graduate of Campbell University, where she earned a Bachelor of Arts in mass communication.