Often people will try to invest in a growth stock because they think that it will give them more returns than a value stock. But growth stock can also be risky. There are many factors that can lead to your stock to lose value. These factors include volatility, dividends, and expectations for future growth.
Choosing between dividends in growth stocks versus value stocks can make a big difference in your long-term returns. You may be wondering how these two types of stocks differ and how to select the right one for you.
Growth stocks focus on revenue growth and profitability. Growth companies are often smaller and less established than value stocks. They also often focus on expanding their business, acquiring new technology, and capitalizing on market demand for their products. These companies also have the potential for rapid appreciation of their share price.
On the other hand, value stocks tend to pay healthy dividends. They typically have low price-to-book ratios and generate small but steady gains in profits. Because value stocks generally trade at inexpensive valuations, they tend to be more stable businesses.
Dividends are not guaranteed, but they do reduce the volatility of a stock’s return. Moreover, companies that pay consistent dividends tend to outperform non-dividend stocks. In the past decade, dividend-paying stocks have been overshadowed by high-priced growth stocks.
Expectations for future growth
During the dot-com era, the so-called “growth-value” spread reached a peak. During this period, technology stocks benefited from increased demand and interest rates that were historically low. These factors helped financial and energy names as well.
But during the pandemic in the United States, value stocks began to regress. Growth stocks, meanwhile, started to rebound. The stock market was upended when the pandemic impacted the economy. Growth stocks were particularly vulnerable because they were trading at lofty valuations. But when the COVID-19 outbreak ended, value stocks began to outperform growth stocks.
Value stocks tend to have low P/E ratios. They also generate small but steady gains in revenue and profits. They can pay large dividends. However, their price fluctuates a lot. They are often late-stage companies.
Growth stocks, on the other hand, tend to be younger companies with little reliable cash flow. They must constantly demonstrate progress in capturing new markets. The market eventually will recognize the value of these companies.
Historically, growth stocks have had a greater volatility than value stocks. This volatility can lead to dramatic changes in portfolios. Depending on your risk tolerance, you may want to consider a mix of growth and value stocks.
Growth stocks are typically associated with technology companies, small companies, and financial institutions. These companies often develop disruptive technologies or offer unique products. Growth stocks tend to outperform during bull markets and economic recessions.
Value stocks are often associated with large financial institutions and established companies. Value stocks typically outperform growth stocks in the long run. They typically hold up better during difficult economic times and are better positioned to pay dividends.
The difference in volatility between value stocks and growth stocks is a result of their valuations. Growth stocks are generally overvalued and have more volatility. However, the gap has narrowed since the last market peak in August.
Growth stocks tend to outperform value stocks in good economic times. This is because growth stocks are generally faster-growing companies. However, this does not necessarily mean that growth stocks will outperform value stocks in bad economic times. This is because valuations are heavily dependent on earnings expectations.
Outperformance over full market cycles
During full market cycles, value stocks have consistently outperformed growth stocks. This is because value stocks have lower stock prices relative to their fundamental metric. However, value stocks are not immune to the risk of uncertainty. They may experience more areas of distress during periods of economic uncertainty.
As with any type of investment, it is difficult to predict how the market will react to a given situation. However, an accurate forecast of deviations from the trend can be very profitable.
Value stocks typically outperform growth stocks in the early stages of a recession, but as the economy grows, they may not see the same return. This is due to irrational market sentiment that pushes growth stocks’ prices up.
Stocks that are sensitive to interest rates have performed well during recessions. This is because interest rates fall and businesses have less money to invest. However, interest rates rise as the recovery matures. This typically leads to a higher inflation rate. Growth stocks have performed better during this period due to superior profitability.