Tune into your nearest financial news channel and within minutes, chances are you’ll hear the words “growth” and “value.” In the parlance of investment jargon these two terms are age-old foes, pitted against each other in the market arena to win the eyes of investors. In reality, growth and value are relative terms that describe companies, their business strategy, and how the financial markets are pricing their future prospects. In this review, we’ll try our best to remove the subjectivity of these labels and illustrate what characteristics define each combatant. From there, we’ll let you take this information and form your own opinion the next time you hear something being coined a growth or value investment.

A growth stock is a company that the market expects to grow faster than other publicly traded companies. Some reasons why this expectation exists could be because the company is dominating its business and competitors, or it operates in an industry that is rapidly growing. Common descriptors for growth companies include “innovative, exciting, uncertain.” Growth companies are usually doing something that gives them a competitive advantage over everyone else, so it has a lot of potential but also many unknowns. When investing in a growth company, investors are buying into the hype that for many years to come, this company will continue leading the pack. From a business strategy standpoint, growth companies tend to invest a lot of money back into the company, or spend all their dough entering new markets and acquiring customers. Therefore, it’s possible that their profitability is (temporarily) lower than it should be. But since investors are paying for the future prospect of windfall earnings, the lower profit today is less important. An example of a growth company could be a technology firm that is developing groundbreaking software that will change the world (think of the internet in the 1990s). It costs millions (or billions) of dollars to research and develop the technology before a single customer buys it. Then when it launches, it might cost billions more to convince customers that it’s something worth buying. However, once that traction hits scale, boom. Hypergrowth. Conversely, there’s always a chance no one buys it, and all that money you spent has no foreseeable return on investment. Growth companies. High risk, high reward.

A value stock is a well-established company that the market expects to continue doing what it’s probably done for years: execute their business and generate strong returns for shareholders. Value stocks operate in traditional industries such as finance, energy, and commodities. As a result, companies within these industries tend to be more sensitive to external shocks that it can’t control, such as global booms/recessions and other economic changes. Common descriptors for value companies include cyclical, cash generators, boring. When the economy is chugging along, the market doesn’t really care whether value stocks are growing, as long as they manage stakeholder expectations and continue operating efficiently. With a focus on current operations, value stocks invest less into the future and return more cash to shareholders (i.e., dividends). However, if the economy gets rocky, things can turn upside down. Business becomes volatile, cash generation gets uncertain, and companies may be penalized by the market. As the stock price gets dislocated from their “steady state” operating model, value may present itself in the form of a company being priced at less than it may be worth. An example is a bank. Let’s pretend it’s the best bank in the world: customers love it and it is a strong operator that consistently delivers to shareholders. But then a recession hits. It’s not the bank’s fault, but suddenly fewer people are borrowing money and customers are withdrawing cash to pay for outside expenses. Business has dried up and cash is tight. From there, shareholders start downgrading their expectations on the company and its stock price goes down. Weirdly, everyone knows this bank is still solid, but no one cares. Its stock price may stay depressed temporarily, or for a very long time. Unfortunately, its recovery depends on whether (and when) the economy rebounds. That’s the conundrum of value stocks. Generally, they are reliable and steady. However, when hit with a shock, the stock price can take a very long time to recover.

One final note, many pundits will use the terms “cheap” and “expensive” for value and growth stocks, respectively. This is referring to the price an investor is willing to pay relative to a company’s earnings. We won’t opine too much on terminology, but we do believe in efficient markets, so will refrain from proclaiming that any value or growth stocks may be trading at premiums or discounts. As mentioned above, if a growth company delivers on its high expectations, its premium valuation may be merited. Similarly, if a value stock’s “temporary” price dislocation lingers longer than expected, its discount could be justified. In our view, the best way to define growth stocks is that its “intrinsic value” depends more on the future. For value stocks, that “intrinsic value” relies more on the present.