When comparing growth vs. value investing, it’s important to look at the pros and cons of each strategy

Value stocks are typically stocks trading lower than their financial fundamentals suggest. They are perceived as undervalued, and have the potential to rise.

Growth stocks are companies that are likely to have sales and earnings growth well above market average. For the most part, they pay little, if anything, in the way of dividends. Instead they typically reinvest any extra cash flow to promote further growth.

Today we’ll look at growth vs value investing so you can choose the strategy (strategies) that best fit your investment goals.

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Growth vs value investing: These two investing styles do not have to compete with one another

If you meet a large number of investors over a large number of years, it may seem they come in two basic categories—one inclined toward value investing, the other more interested in growth. This may be due in part to their early life experiences.

Value investing—trying to buy assets at bargain prices—has natural appeal for those who grew up in strained economic circumstances. Growth investing—trying to identify and buy rising stocks when they have further growth ahead—seems to appeal more to those who grew up in prosperous households.

Growth vs value investing: How to be a successful value investor

You need an eye for value to succeed as an investor.

High-quality “value stocks” are reasonably-priced stocks, if not cheap, in relation to its sales, earnings or assets. Investors hold onto them because they expect that other investors will recognize their value and push up the share price.

When you look for stocks that are undervalued, it’s best to focus on shares of quality companies that have a consistent history of sales and earnings, as well as a strong hold on a growing clientele.

High-quality value stocks like these are difficult to find, even when the markets are down. But when you know what stocks to look for, you can discover them. We employ three financial ratios as a useful guide to spotting them:

• Price-earnings ratios
• Price-to-book-value ratios
• Price-cash flow ratios 

Growth vs value investing: How to be a successful growth investor

Growth vs value investing: Find out what the most successful growth investors already know.

To profit from growth stocks, you need to pick stocks with clear growth prospects and not simply momentum stocks with uncertain futures.

Although these stocks can be highly volatile, they often make good long-term investments. They may be well-known stars or quiet gems, but they do share one common attribute—they are growing at a faster-than-average rate within their industry, or within the market as a whole, for years or decades.

Chosen wisely, high-quality, growth-oriented stocks can be worthwhile additions to most well-diversified portfolios.

Growth vs value investing: Use both together for best results

Growth vs value investing: Use them together for the best investment returns

Academic studies suggest that on average, value investing produces better results than growth investing. But these studies mostly look back on what would have happened in a particular historical period, if you followed a particular set of rules. Most distinguish between growth and value investing by looking at average p/e’s (ratios of per-share price to per-share earnings). They assume high p/e’s are a marker for growth stocks and low p/e’s for value stocks. As any serious value or growth investor can tell you, it’s more complicated than that.

If you balance and diversify your portfolio as we recommend, it should include both growth and value selections. In both areas, you should avoid extremes.

Most successful investors will hold some growth stocks and some value stocks at any given time, depending on where they discover the best opportunities.

Together, growth stocks and value stocks can form a winning combination. A growth stock can be a top performer while the company is growing. However, a single quarter of bad earnings can send it into a deep, though often temporary, slide. Value stocks can test your patience by moving sluggishly for months, if not years. But they can make up for it by rising sharply when investors discover their true value.

Bonus Tip: Dollar-cost averaging

If you want both your growth and value investing strategies to be profitable for decades, you should also use a technique called dollar-cost averaging. That’s when you buy stocks gradually during the course of your working years. By using this strategy, market declines will have little impact on your long-term profits.

All in all, if you implement dollar-cost averaging and a solid growth or value investing strategy, you’ll lower your risk considerably.

It’s possible for top value stocks to have hidden problems. Have you experienced this in your investing career, or do you have a strategy in place to protect yourself?

Growth stocks have a lot of potential, but they can be risky. Have you lost money on a growth stock? How long did it take before you decided to cut your losses?