In general, there are 2 types of stocks – value stocks and growth stocks. Deciding on which to invest in can be quite a tricky task since each of them has their own pros and cons. However, one should know the difference between the 2 types before jumping into the critical decision making phase.
1. Growth Stocks
Growth stocks are normally stocks which have shown a steady growth rate over the past 5 years. For a smaller company, it must have a steady growth rate of about 10% while for a larger company, the growth rate should be around 7% for the past few years. You should also check out the projected growth rate of the company which should be around the same as the values mentioned before this. Do bear in mind that larger companies tend to have slightly lower growth rate than smaller companies. It could be due to the more complex business models or the larger workforce owned by the larger companies. However, there are exceptions where a large company can outgrow a smaller company.
When choosing a growth stock, you should always check the company’s previous annual and financial reports (at least 5 years). Does the company have a steady growth and profit? Is the latest pre-tax profit higher than the average profit of the previous years? Also, pay attention to the prospectus and see whether the company’s direction is in line with what the market needs. Is the company being too ambitious (higher risks) or too slow for your liking (not enough growth)? Try to do some research on the projected stock price and calculate how much you will earn few years later if you were to buy this stock. Compare the findings with other growth stocks which you have shortlisted and see which one is the best for you.
Always remember that growth stocks do have their share of risks since most of them are small (some are new) companies. By making a wrong choice, you might end up with nothing since the company might close down. But high risk brings high rewards. Google used to be a small company with a promising future. It was a growth stock and take a look at its current stock price. You would have been a very rich guy if you have invested in Google when it first started.
2. Value Stocks
Value stocks are normally more expensive than growth stocks due to their strong fundamentals. They are called value stocks because of their lower-than-average stock price. Some people call them as bargain stocks. Their undervalued price might be caused by overselling pressure. It is your responsibility as an investor to do your research thoroughly and find out the reasons behind the overselling. This is very important because you would not want to buy a “value stock” which has a debt higher than its equity.
When deciding which value stocks to buy, one should always look at the Price Earnings ratio (P/E ratio). Compare the company’s P/E with other companies in the same industry and also with the other value stocks. If it is one of the lowest, you should definitely shortlist the stock and proceed to the next analysis phase. Check the company’s assets and liabilities. Does the company has assets more than liabilities? What about the company’s future performance? Is the projected stock price showing a positive sign?
At the end of the day, choosing a value stock is about choosing an undervalued stock with good (or very good) potential to rebound in the near future. Ensure that the value stock you are choosing have the means to make this rebound. Also, be prepared to hold the stock for few months and maybe up to 3 years because a significant rebound might take some time to materialise.
Growth stocks tend to have higher risk but also higher long-term return. If done right, the profit gained might be significantly more than the profit gained from investing in value stocks. However, according to the experts, one should always adapt a more diversified portfolio with a mixture of value and growth stocks.
In my opinion, there is no one investment type which is better than the other. Whether being a value stock investor, a growth stock investor or a diversified stock investor is better, it is up to you to make the decision. The most important thing is to find the one which suits you most and stick to it.
Good luck and hope it helps!