Growth Stocks or Value Stocks?
As financial planners, we are often told by clients that they want “growth” in their portfolios. What exactly is “growth”, and is investing in “growth” stocks the best way to achieve a larger investment portfolio?
Historically, stocks have been divided into 2 camps – growth stocks and value stocks. Growth stocks typically are young companies, developing or selling a new product or service. Because they need funds for investment in production facilities, they often do not pay a dividend. On the other hand, value companies are usually older companies selling a well-established product or service. They often pay a substantial amount of their earnings back to the stockholders in the form of dividends. Growth stock companies are “in the news” because of their spectacular price rises, for example, Tesla. Frequently, the names of growth stocks are not familiar. However, value companies are older and have well-established products, so their names are common, for example, AT&T or General Electric.
Surprisingly, over a long period of time, value stocks outperform growth stocks. This seems paradoxical only because growth stocks have outperformed value stocks in the past few decades. There are several reasons for value stocks to out-perform. The most important are the dividends that value stocks pay. If re-invested, this steady stream of re-invested money allows the portfolio to grow better than the “capital gain only” growth stocks. Value stocks are usually cheaper to buy at any given time, and the cheaper the stock, the more of that stock someone can buy. Although some growth companies succeed spectacularly, others fail completely, and it is difficult to know which companies to buy in their early stages of growth.
Finally, the growth of an individual company is dependent, to some extent, upon the growth of the economy in general. It is unlikely that any, but a few companies can grow their earnings impressively when the economy is not. Presently, the mature economies of the USA, western Europe, and Japan are growing slowly because of an aging population, a stagnant or shrinking labor force, excessive debt (personal, corporate, and national), and declining productivity.
A wise maxim goes like this: “a bird in the hand is worth two in the bush” and a dividend check in the hand is often better than an ephemeral capital gain. The tide may be turning toward value stocks again.