What are the growth stocks and the value stocks?

Those who are financially literate prefer to invest in the stock market while others delegate this to their consultants to start their financial journey. 

We generally hear the terms Growth Investing and the value investing in the financial world but most of us are not exactly clear about their meaning and the implementation. ​Although, there is no hard and the fast rule that define these terms but there are certain general criteria which set apart these two financial terms.

Growth stocks

The Growth stocks are those companies which generate substantial positive cash flows and whose earnings are expected to grow at the faster rate than the average market rate.

• Growth stocks have high P/E ratio. It is the ratio of the market price per share to the current year’s earnings per share. For example, a company ABC ltd has a market price of Rs. 240 per share and its earnings per share in last 12 months is Rs. 10 per share, then its P/E ratio is Rs. 240/ Rs. 10 = 24.
• These companies generally have high Return on equity with respect to the Industry average.
• A high P/B ratio (share price is divided by the book value per share) is one of the characteristics of growth stocks
• There is consistent growth in their EPS year on year.
• The market generally sees them as performer and this is the reason that investors are willing to pay more for these stocks.
• Although, they sometime pay dividends to their investors but the management of these companies generally prefer to re-invest the retained earnings for the further growth and the expansion of the company.

If the selected stock meets 90% of the above mentioned criteria, then most likely you are looking for a growth stock.
The growth stocks are generally over valued and expensive but because of their inherent nature to grow; these companies are preferred by the investors in spite of their high price.

Value stocks

• These companies have strong fundamentals which are not really recognized or overlooked by the broader market segment and because of this reason they have low market price, low P/E ratios and low P/B ratios.
• These companies generally have market price less than their intrinsic value. For example, a company XYZ ltd is trading at Rs. 90 per share which has its intrinsic value of Rs. 100 per share. It has potential to grow and reach its intrinsic value.
• The PEG ratio should be < 1, which indicates that the company is undervalued.
• The Debt to Equity ratio of these companies is <= 1. A company having less debt with respect to its equity is more likely to perform and deliver than a company having higher proportion of debt with respect to its equity.
• These stocks have current ratio (Current assets / current liabilities) > 1. It means that they have sufficient amount of cash to perform their day to day operations and meet their short term obligations.

Investors search and buy these stocks in anticipation that one day the broader market will recognize the potential of these stocks and their market price will increase. But this recognition may take long time or may never be realized.

Conclusion

The growth investing and the value investing are the investment styles which are adopted by the investors. At one time you may find that value investing is giving better returns while on other growth investing is appreciating with time.
Therefore, understanding the basics of both the investment styles may help you to take your investment decisions prudently. Keeping both types of stocks in your portfolio can help you to increase your returns and manage your risk effectively and efficiently.