Value and growth are a little bit more technical terms than most investors understand, but what I want to teach today is how investing in stocks can be a science rather than a guessing game or a luck game. We have looked at Nobel Prize winning data to figure out exactly what type of stocks have the highest expected return based on history of the last 80 plus years. Today we are going to tackle one small section of what type of stocks you should be investing in. The Value Stocks vs. Growth Stocks discussion.
Value Stock– A stock that has a low price compared to it’s financial data, usually because investors don’t “feel good” about that company.
Growth Stock – A stock that has a high price compared to it’s financial data, usually because investors expect that company to grow very fast.
Which one is better?
You might think that growth stocks (S&P 500) might have more long term “growth” potential, but you would be wrong. Check out this chart that proves exactly the opposite.
The chart is showing 2 examples of value beating growth. First the green example with the first bar being value and the 3rd bar being growth. Then identical with the blue bars. As you can see on this chart, whether with large stocks or small stocks, there is a premium when you invest in value companies. And it is not just a little difference. Over 2% difference in large stocks, and over 6% in small stocks. That is huge. Did you know that the historical return for small value stocks is almost 15% per year. Does that blow your mind? Many surface investors miss out on this investing “secret” because this is not in the news or media. Value companies are not popular and are rarely if ever talked about. It is not cool to invest in value companies.
Why is that?
Because there is a greater risk involved in investing in these value companies, there is also a greater reward. Value companies have low earnings and shaky financial health, thus they are riskier to invest in. Just like banks would charge these companies a higher rate on loans, you the investor can expect a higher rate of return from investing in their stock.
Most financial advisors stay away from value companies because they are uninformed about how to prudently invest in these companies. If you invest in widely diversified portfolio with at least some portion in bonds, you can increase your long term growth immensely by investing a greater percent of your portfolio in value and less in growth.
by Jimmy Hancock
1. Matson Money. Understanding the Dimensions of Risk and Return. N.p.: n.p., n.d. PPT.