Investing in the stock market is a common way for people to establish savings and grow funds for retirement, education and other purposes. While the stock market can and often does provide a good return on an investment, it is also possible for buyers to lose some or all of their money. Analyzing the market and making careful choices is one way to help minimize this risk, such as deciding whether to purchase value stock or growth stock.
Value stock is trading at a price that is lower than expected based on its history of dividends, sales and earnings. Such stocks are identified by certain characteristics, such as a low price to earnings ratio of no more than 10 percent, and a price to earnings growth ratio that is one or less. Stock price should not exceed its tangible book value, and the company’s amount of debt should be about equal to its equity, with liabilities equal to no more than half of the value of the company’s total assets. Value stocks may be the result of the newness of a company, poor performance, legal problems or other issues that cause investors concern about long-term stability.
Growth stock comes from a company whose earnings are anticipated to grow faster than other, similar companies. Such stock has a history of stable, regular increases in the value of the stock, and this growth is expected to continue. The earnings per share are higher than the average for similar types of stocks, and the return on equity is also higher than average. The price for these stocks is usually higher than average.
Many people are firmly convinced that one type of stock is better than the other, but some feel that the two types can work together to create a more balanced, stable portfolio. Buyers of growth stocks seek to buy stock in solidly established companies that have shown strong performance in the past and are likely to continue to do so. Value stock buyers look to companies that have the potential to recover from any temporary problems that may be causing the stock to be low in the short term. Buying both helps to diversify a portfolio.
There are significant risks associated with both value and growth stocks. Value shares may become worthless if the company is unable to recover from the problems that caused its stock to be low in the first place. A new company or a financially distressed one may go out of business with little or no notice. Growth stocks can also be risky, since even though the companies are considered solid, a bad financial report or the failure of a new product can cause stock prices to plummet and lose investors significant amounts of money. Current market trends impact the risk of both types of stock.