Growth vs Value

Identifying if you’re investing in growth or value

One of the most useful questions you can ask when researching a stock is simple:

What kind of company is this, really?

Not all shares should be judged in the same way. Some companies are priced based on what they might become, and others are valued on what they already are. Understanding the difference is critical, otherwise you risk applying the wrong expectations and making poor decisions as a result.

What is a Growth Stock?

A growth stock is a company expected to increase its revenue and profits faster than the market average. These businesses are often either expanding into new markets, launching new products or reinvesting heavily into growth.

They usually have high revenues, high price to earnings (P/E) and price to book (P/B) ratios. These businesses reinvest profits to expand the business, rather than pay dividends. 

👉 Check out the P/E ratio using the LSE screener tool

Because of this, they are typically valued on future potential, not current performance.

That means that profits may be low (or non-existent), valuations can look high, and expectations are built into the share price. 

Investors are effectively paying for what the company could become, not just what it is today.

What is a Value Stock?

A value stock is usually a more established business that generates consistent revenue, is already profitable, and trades at a lower valuation relative to its earnings or assets. They pay regular dividends.

These companies are often slower growing and more stable in their operations, but they are sometimes overlooked or out of favour with the market. They are often described as the workhorses of the market - not particularly exciting, but dependable in how they operate.

Investors are typically buying based on current fundamentals, with the belief that the market has undervalued the business and that its true worth will be recognised over time. However, it’s important to recognise that some stocks are cheap for a reason, and a low valuation does not automatically mean low risk.

Why the Distinction Matters

It’s important to recognise which type of stock you’re dealing with, so that you can manage expectations.

A growth company with high expectations can fall sharply on even small disappointments. It doesn’t need to perform badly, it just needs to perform less well than expected.

A value stock, on the other hand, may appear “cheap” for a reason. If the underlying business isn’t improving, it can stay cheap indefinitely.

The question to ask yourself is whether the company is performing in line with what the market expects of this type of stock.

Identifying Growth vs Value

How do you know which is which? As a starting point, the two sectors that are generally considered growth are consumer discretionary and technology. Whereas value sectors would usually be financial, industrial, energy and consumer staples. 

From here, you can check by looking at a company’s revenue growth, profitability, dividends, valuation, and narrative. 

Revenue growth: Is it increasing quickly, steadily or flat?

Profitability: Is the business already generating strong profits?

Dividends: Does the company pay dividends or reinvest profits into the business?

👉 You can see which companies pay out dividends here

Valuation: Does the share price look expensive relative to earnings?

Narrative: Is the company talking about expansion and future opportunity, or stability and returns?

The answers to these will quickly tell you whether you’re dealing with growth or value.

The Trade-Off

Value stocks often perform better in recessions, bear markets, or periods of low interest rates. Whereas growth stocks tend to outperform in bull markets and economic upturns. 

Whether you decide to invest in growth or value stocks (or a mix of both) will depend on your risk tolerance and goals. Your approach should reflect what you’re comfortable with, and what you’re trying to achieve.