Growth investing vs value investing
Guide Summary
- Growth investing targets companies expected to grow faster than the market, often reinvesting profits and offering high return potential with higher risk.
- Value investing seeks undervalued companies with solid fundamentals, aiming for more stable returns.
- Your ideal approach between value and growth investing depends on your personal goals, risk tolerance and investment timeline.
What is growth investing?
Growth investing targets companies that investors believe have the potential to grow faster than the broader market.
These are often newer companies or those operating in rapidly expanding industries like technology, renewable energy, or healthcare innovation.
Key characteristics of growth investing
- Emphasis on capital appreciation over income (e.g. dividends).
- Companies often reinvest profits to fuel future growth.
- Share prices tend to be more volatile but can offer higher returns over time.
- Commonly priced higher relative to earnings (higher P/E ratios).
Growth investing is typically more suitable for investors with a longer time horizon and a higher risk tolerance, as the payoff often comes from future potential rather than current earnings.
What is value investing?
Value investing involves identifying companies that appear to be undervalued by the market.
These are stocks trading below their intrinsic value based on fundamental analysis (like cash flow, earnings, or book value).
Key characteristics of value investing
- Focus on finding stocks perceived as mispriced.
- Often includes established companies with stable earnings.
- Generally provides dividend income as well as capital growth.
- Less volatility, but potentially slower returns.
This strategy may appeal to more conservative investors looking for steady returns and lower downside risk.
Examples of Growth and Value Investing
To better understand how these strategies play out in practice, consider how growth and value investors might view the same market differently.
Growth
- A growth investor may be drawn to a fast-growing technology firm that has yet to post consistent profits but is expanding rapidly, reinvesting all earnings into product development and market share.
- Despite a high valuation relative to current earnings, the investor believes the company’s future potential justifies the price. Sectors like software, green energy, or healthcare innovation often fall into this category.
Value
- In contrast, a value investor might look for a well-established consumer goods company with stable earnings, consistent dividend payouts, and a share price that appears low relative to its earnings or book value.
- The belief is that the market has temporarily mispriced the company, possibly due to short-term concerns, and that the share price will eventually recover as fundamentals prevail.
Both strategies can be applied using individual stock selection or through diversified investment funds, which pool companies with similar characteristics.
Many UK investors use index funds or ETFs tailored to either value or growth styles as a simple way to gain exposure while mitigating individual stock risk.
The Key Differences Between Value and Growth Investing
While both growth and value investing aim to build long-term wealth, they differ in philosophy, risk profile, and timing.
Growth investing is forward-looking. It relies on the market eventually rewarding companies for their innovation and rapid expansion. This often means accepting higher volatility and short-term uncertainty in exchange for the potential of above-average returns.
Value investing, on the other hand, is based on the premise that markets can misjudge a company's worth. By purchasing undervalued companies with strong fundamentals, value investors aim to benefit as the market corrects itself.
How to Decide if Value or Growth Investing Is Right for You
Choosing between growth and value investing depends on several personal factors:
- Investment goals: Are you aiming for long-term capital appreciation, or are you seeking steady income and lower volatility?
- Time horizon: Growth investing usually requires a longer time frame to ride out market swings. Value investing may suit those with a medium to long-term horizon looking for more stable returns.
- Risk tolerance: If you're comfortable with market fluctuations and are focused on potential gains, growth may appeal to you. If you prefer less risk and more predictability, value could be a better fit.
- Behavioural tendencies: Some investors struggle with holding onto volatile growth stocks through downturns. Understanding your emotional response to risk is just as important as the numbers.
In reality, many investors find a blend of both strategies provides balance, with growth driving long-term returns and value offering stability.
Growth and value investing summary
Understanding the core principles of growth and value investing helps lay the foundation for a more thought out and tailored investment strategy.
While growth investing seeks to capitalise on future potential, value investing focuses on capitalising on perceived mispricings today. Each has its strengths and trade-offs.
By aligning your personal goals, risk tolerance, and time horizon with the appropriate strategy, or combination, you can build a more resilient investment portfolio.
In the next guide, we’ll explore how you can begin to put these strategies into practice through building passive income, a key step in creating financial freedom and long-term wealth.
When investing, your capital is at risk. The value of your investments can go down as well as up and you may get back less than your original investment. Chip does not offer financial advice and this should not be considered as a personal recommendation. Diversifying means spreading your investments across different sectors, countries and asset classes.
