There doesn’t need to be a competition between value vs. growth stocks. We believe both types of stocks have a place in a well-diversified portfolio

What should you choose when looking at value vs. growth stocks? We think you should pick some of both.

Value vs. growth stocks: Tips for growth investing

To profit from growth stocks, you need to pick stocks with clear growth prospects.

By definition, growth stocks are companies that have above-average growth prospects. They are firms whose earnings growth has been above the market average, and is likely to remain above average. It is often the case that they pay small dividends or none at all. Instead, they re-invest their cash flow in their business, to promote growth.

Although these stocks can be 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 projected to grow at a higher-than-average rate within their industry, or within the market as a whole, for years or decades.

Value vs. growth stocks: Tips for value investing 

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

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.

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High-quality value stocks like these take some work to find, even when markets are down. But when you know what kind of stocks to look for, you can discover them. Here are three of the financial ratios we take a look at as a useful guide to spotting them:

• Price-sales ratios
• Price-to-earnings ratios
• Price-cash flow ratios

Value vs. growth stocks and investor appeal

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.

Value investing—aiming 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.

Value and growth both appeal to me. But value investing seems safer. That’s a common misconception. In fact, value investments may only be cheap due to hidden problems. I learned that lesson when one of my earliest value investments collapsed. It was cheap in relation to its asset value, but its asset value shrank drastically after it wrote down the value of its inventory.

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 income investing by looking at average p/e’s (per-share price-to-per-share earnings ratios). 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.

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.

All in all, 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.

Value vs. growth stocks: Balancing your portfolio

Building a balanced portfolio can include a mix of growth and value stocks, big and small stocks, and so on. But most important, it should be balanced across most, if not all, of the five economic sectors.

What constitutes a well-balanced portfolio depends in part on your investment objectives and financial circumstances.

Here are some tips on diversifying your stock portfolio:

• When it comes to a diversified stock portfolio, stocks in the Resources and Manufacturing & Industry sectors in general expose you to above-average share price volatility.
• Stocks in the Utilities and Canadian Finance sectors entail below-average volatility.
• Consumer stocks fall in the middle, between volatile Resources and Manufacturing companies, and the more stable Canadian Finance and Utilities companies.

Conservative or income-seeking investors may want to emphasize utilities and Canadian banks for their high and generally secure dividends.

Always follow our three-part Successful Investor approach when buying both value and growth stocks

1. Hold mostly high-quality, dividend-paying stocks.
2. Spread your money out across most if not all of the five main economic sectors: Manufacturing & Industry, Resources & Commodities, Consumer, Finance and Utilities.
3. Downplay or stay out of stocks in the broker/media limelight.

Will growth or value stocks be more dominant over the next year?

Why do you prefer growth stocks or value stocks? Have you found that one or the other is a better fit for your portfolio?