Investors that are active in the stock market will come across two types of stocks. These include value and growth stocks. Both of these stocks provide varying risks and rewards. On top of that, there are several other differences that set these stocks apart. While there are no specific definitions for what value or growth stocks are, there are some distinguishing characteristics that each of these stocks illustrates.
What is Value Stock?
Value stocks represent any shares traded in the stock market that have a market value lower than their intrinsic value. Intrinsic value represents the present value of all expected cash flows from that stock discounted at an appropriate discount rate. As the market price for these stocks is lower than what they should be worth, value stocks represent undervalued stocks.
Due to the lower prices, value stocks have the potential to realize their intrinsic value. If an investor buys value stocks, they have the opportunity to benefit if the stock’s intrinsic and market values equalize in the future. The primary source of return on value stocks is the income that investors will get from the price differences.
What is Growth Stock?
Growth stocks represent any shares traded in the market that have a significantly higher estimated growth rate. Usually, most stocks in the stock market promise growth. However, growth stocks illustrate a higher growth rate than the market average. It means that these stocks have the potential to outperform the market in the future.
Unlike value stocks, however, growth stocks have similar market and intrinsic values. Therefore, investors do not have the opportunity to benefit from any profits from price differences. Sometimes, growth stocks may also come with a valuation higher than their intrinsic value due to the higher potential growth in the future. The primary source of return for investors with growth stock is the future growth in earnings.
What are the differences between Value and Growth Stock?
The above definitions of value vs growth stocks should allow investors to understand the differences between these stocks. However, there are some other characteristics that distinguish value and growth stocks. One of these differences includes the methods investors use to differentiate between value vs growth stock.
Usually, investors calculate the intrinsic value of several stocks and compare it to their market value. On top of that, they may use ratios such as the price-to-earnings ratio, price-to-equity ratio, current ratio, etc. Based on these, investors can determine if a stock is undervalued. In contrast, investors look at metrics such as earnings per share, earnings before taxes, return on equity, etc., to identify growth stocks.
Value and growth stocks also differ according to the company’s size. Usually, value stocks come from large, well-established companies. The difference in their stock valuation may come from temporary factors. On the other hand, growth stocks may consist of companies of all sizes. However, these are not established companies. Instead, these companies have a substantial potential to grow in the future.
Lastly, value and growth stocks are different in the risks they involve. As mentioned, value stocks are from well-established companies. Therefore, the risks involved in value investing are lower. However, these also provide lower returns. On the other hand, growth stocks have higher risks but come with potentially higher returns.
Conclusion
Investors often confuse value and growth stocks. However, both of these are different from each other based on several characteristics. Value stocks represent undervalued investments that will return to their market value in the future. Growth stocks, on the other hand, are stocks that promise higher growth than the market average.
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