If you’re just getting your feet wet in the world of investing, stocks may seem to be the best way to get started. While financial advisors will likely suggest that a certain portion of your portfolio contain stocks, it is important to realize that there are two primary styles of stock investing — value and growth.
At any given time, one style or the other may be the best bet for you. Oddly enough, at times you may even be better off employing both styles. Even if you start off with one style, changes in your lifestyle or the market may lead you to make a switch to the other or use both styles at once.
Value investing involves choosing stocks that may have an unappreciated potential — those that may not be the most popular in the market at the moment but that have sound fundamentals and might be poised for a turnaround. Value investing involves searching for a company that appears to have a good financial future, but that the market either doubts or has not yet noticed. It includes buying stock in these companies before the market fully recognizes them, and then waiting for the market to see their true value.
To help identify a value stock, look for some of these characteristics:
• Value stocks generally trade below their intrinsic value (private market value per-share). In other words, their stock price does not reflect what the company actually would be worth if all its assets were sold.
• Value stocks often have higher dividend yields. These companies can be more oriented toward paying a dividend rather than reinvesting for growth.
• Value stocks may have hidden value such as land, assets, property, patents or other investments that investors may overlook.
• Value stocks often have a lower growth rate than growth stocks.
• Value stocks may be more sensitive to the economy than growth stocks. An improving economy may spur higher earnings and drive up a value stock’s price. Thus, value stocks often outperform growth stocks early in an economic cycle.
Growth investing focuses on stocks that experience faster-than-average growth and are expected to continue such positive trends. Past performance, however, is no indication of future results.
When deciding whether a certain stock is a growth stock, you may want to look for the following characteristics:
• A growth stock usually shows higher revenue and earnings growth potential relative to its industry.
• Growth stocks are often industry leaders in sales and profits and often have the highest price-to-earnings ratios.
• Growth stocks usually have low or non-existent dividend yields because the profits are generally reinvested back into the company as opposed to being paid out as dividends.
• Growth stocks’ earnings often compare best when the overall economy’s growth begins to slow. Thus, growth stocks have tended to outperform value stocks later in the economic cycle.
Before deciding on what style is best suited for you, and to avoid some of the volatility any particular investment may offer, you may want to use a more defensive technique by combining both these types of investments. This strategy would allow you to capture blended returns with blended risk. Your financial advisor will also be able to help you decide the best investment style for your needs.
Brian Hepp is a financial consultant and can be reached at (310) 453-0077 or at email@example.com.