If you have ever read investment or personal finance literature or articles, you’ve probably come across the terms ‘growth’, ‘value’ and ‘income’ attached to different companies or funds. What’s the difference and the significant to investors and possibly your own investment portfolio?
How And What You Invest In Can Change With Your Investment Aims and Priorities
There’s a whole world of different investment products and strategies out there. That’s a good thing because different kinds of investments have different qualities and different investors different priorities and investment aims. And these can change over time. Choice between categories and sub-categories of assets with different strengths and weaknesses means no matter your personal investment aims and priorities there are options.
So no matter if your investment portfolio has a 5,10,20 or 30-year horizon before you plan to start cashing it in or drawing an income from its returns, you have a choice of different asset mixes. The same applies to investors who might be in a position to take a little more risk with a part of their portfolio in the pursuit of higher returns. Or those whose priority is value preservation.
‘Growth’ and ‘value/income’ are terms that are applied to broad, approximate categories of company shares and also sometimes funds. They are used as a guideline of qualities experts think these investments have that relate to their role in a wider portfolio. The balance between these different kinds of investments usually changes depending on an investor’s priorities and aims.
What’s The Difference Between ‘Growth’ and ‘Value/Income’ Shares And Funds?
Shares or companies referred to as ‘growth’ are those which, as the name suggests, are growing quickly = more than the market average and often significantly. They could either have a brand new product or service which is gaining traction as people learn about it and start to use it. Or a new, improved version of an existing product. Or be a disruptive service or commercial model. Sometimes a growth company can tick more than one of those boxes. Whatever the reason, the company’s customer base, users, revenues or some combination of the three are growing quickly.
These companies tend to plough most of their revenue, and sometimes also capital raised by selling their shares when listing on the stock market, into continuing to grow by spending on expanding geographically, or increasing production capacity, hiring staff, marketing, research and development for new products and so on. As a result, they don’t pay shareholders any dividends. That means if investors want to realise a return on investment, they have to sell their shares at a higher price than they bought them. That relies on other investors deciding the company will keep growing and increasing in value.
The market value of growth stocks is usually based on expectations of future revenues and profits rather than those being earned now. That gives them a higher risk profile as there are many unknown future factors that could mean they don’t actually eventually succeed in earning those revenues or profits. The share price could then fall and investors take a loss. But if they do, or even exceed those expectations, their value should rise even more, earning investors portfolio-boosting returns.
Technology stocks are most often in the growth category but so are young pharmaceuticals or biotech companies and there are examples from most industries that are considered growth stocks.
Value stocks, on the other hand, are pretty much the opposite profile of growth stocks. They are companies not currently en vogue with investors, leading to lower demand and value for their shares. But their fundamentals, which means a combination of profitability, value of assets, future prospects and more, are still strong.
They are also not usually growing quickly, usually slower than the market average, but have a stable business model that generates good profits. Because value companies are not investing a big portion of those profits into growing more, they pay a good chunk of them out to shareholders as dividends. They usually have a value which, as a multiple of annual revenues, is lower than the market average.
The qualities of what are often referred to as income stocks are very similar, which is why the two categories are often rolled into one. But it could be said that an income stock pays better dividends than the market average but is not necessarily valued at a lower than average multiple of annual revenues.
Utilities and energy companies often fall into the value and income stocks categories, as do financials such as large banks. But like growth stocks, it is theoretically possible, and often happens, that companies from almost every industry fall into the value or income categories.
Value and income stocks, though still risky, are sometimes considered to have a somewhat lower risk profile than the overall stock market because their share price is a reflection of current earnings, rather than future potential. Investors in value stocks also hope the market will again recognise their strong fundamentals, leading to them becoming more popular again and the share price rising as well as providing income from dividends. The risk, of course, is that earnings and profits fall in the future and dividends dry up and the share price falls further.
Value stocks and growth stocks have both had periods when one category has outperformed the other. Growth stocks, as a whole category, have given investors better returns than value stocks, as a whole category, since the financial crisis of 2008. But between 1998 and 2008, value stocks did better than growth stocks with investors especially nervous of tech stocks after the dotcom crash.
Growth, Value or Income funds are generally made up of a majority of stocks from those categories and have the overall target of giving investors the advantages associated with the different company categories. So an increase in overall value for growth funds and dividends and potentially reduced risk when compared to the total stock market in the case of income and value funds.
When Should I Invest In Growth Stocks and When In Value Stocks?
A well balanced investment portfolio will usually contain both growth and value/income stocks because history shows there is no guarantee which category will do better over a particular period of time. But the balance can change over time. Investors who are ready to take on a little more risk in the hope of higher returns might invest more in growth stocks. On the other hand, investors who want to make sure their investment portfolio doesn’t lose value would be expected to invest more in value and income stocks.
As a result, it is common for investors who are a long time from when they expect to cash in their investments to have a higher ratio of growth stocks in their portfolio. That will often gradually decrease in favour of value and income stocks the closer it gets to the time the investor expects to start to cash in the portfolio.