Understanding value vs. growth investing

Understanding the difference between value vs. growth investing can help investors respond to periods of market turbulence like the 2020 pandemic. Value stocks trade below what they are worth, while growth stocks do not yet pay a dividend but offer big potential for the future.

As financial markets move up and down in response to economic, political and business developments, considering the factors behind a stock’s price can give investors the tools to make long-term investment decisions. This includes understanding the difference between growth and value stocks, which can help you decide what to do when markets are in turmoil.

What is value investing?

Value stocks are stocks that stand out by their low valuation relative to their fundamentals (e.g. earnings, dividends or sales). They often have high dividend yields and tend to be more sensitive to the business cycle. In short, value stocks tend to belong to companies that have a solid long-term business but are trading below what they are really worth due to a short-term setback in market conditions.

Because they are sensitive to the business cycle, a temporary change in market conditions makes these companies appear to underperform. Value investing is about identifying companies that fall in this category. While evaluating value stocks, investors should focus on understanding the fundamentals of the business vs. the (low) valuation.

This way, investors are able to invest in a stock that is undervalued and has potential to deliver returns over the long term once the markets recover after a period of turbulence.

What is growth investing?

Growth stocks, on the other hand, are stocks of companies that offer substantial growth prospects. They are often disruptive and bring innovative products or services to the market. Their business is typically growing fast, but they use most of their earnings to finance that growth and often do not yet pay dividends.

Growth investing is about capturing this value over time. Investors in growth stocks hope to make returns based on the long-term potential of the company rather than its current performance.

Value vs. growth investing during market turbulence

Value and growth stocks diverged in performance during 2020. Understanding why can also help investors unearth returns in the financial markets.

Graph shows how earnings volatility in percentage of value vs. growth stocks has evolved over time between October 1995 and October 2020. Source: Datastream and Credit Suisse.

Earnings volatility of value vs. growth stocks in %

The pandemic has accelerated factors that position for growth investing, such as the ability to meet the shift in demand caused by decreased mobility, social distancing and remote working and learning. At the same time, relevant parts of value face structural challenges, such as car companies struggling with CO2 emissions.

In 2020, we witnessed a strong divergence in returns between growth and value stocks. Going into 2021, Credit Suisse’s latest Investment Outlook publication outlines their view that value stocks have the potential to catch up, though the timing of such a rebound is not quite clear.

Source: Credit Suisse