Growth vs Value Investing: Which Is Best For You? (2024)

Investing is always about buying assets with a goal of securing the best possible return on your money. But how do you judge whether your investments are positioned to get the best possible return?

Growth investing offers one answer to that question: Buy companies that are growing their revenue, profits or cash flow at an above-average rate. There are other strategies, however, like GARP investing and value investing, that offer different approaches.

Let’s take a closer look at growth investing and some of the alternatives to its high-valuation, high-growth formula.

What Is Growth Investing?

Growth investing is an investing strategy that aims to buy young, early stage companies that are seeing rapid growth in profits, revenue or cash flow. Growth investors prefer capital appreciation—or sustained growth in the market value of their investments—rather than the steady streams of dividends sought by income investors.

In the current market, growth companies include Tesla (TSLA), Amazon (AMZN) and Facebook (FB). But even older, less tech-savvy companies can be considered growth investments. For example, today Home Depot (HD) is categorized as a growth company.

Understanding the life cycle of companies is key to understanding growth investing. In the early days of a new company, business may be growing at a substantial pace, generating impressive gains in revenue and profits. At this stage in its life cycle, a company typically reinvests profits back into the business to drive further growth, rather than paying them out as dividends.

As the company and its markets begin to mature, growth in revenue and profit slows. Once the company is fully mature, growth slows further. At this point in the cycle, many companies begin to distribute profits to investors in the form of dividends as the investment opportunities available in their markets begin to diminish.

Growth Investing vs. GARP Investing

Growth companies often appear expensive when analyzed with standard valuation metrics, such as the price-to-earnings (P/E) ratioand price-to-book (P/B) ratio. In some cases, growth stocks have P/E ratios and P/B ratios that are astronomically high.

For example, as mid-September 2020 growth investing darling Amazon had an astonishing P/E ratio of 128 and a P/B ratio of more than 22.

Growth investors look past the expensive valuations of the present to the even richer expected growth of a company in the future. In theory, that future growth may deliver a very favorable ROI. The question remains, however, whether this “growth at any price” approach to investing is sustainable.

To address this, some investors pursue a strategy that looks for reasonably priced growth companies called GARP investing.

What Is GARP Investing?

GARP investing, or growth at a reasonable price investing, looks to balance growth against high valuations. GARP seeks out growth companies that are priced in line with their intrinsic value. Famed investor Peter Lynch popularized the GARP strategy.

As noted above, thekey challenge of growth investing is an investor’s ability to forecast a company’s growth prospects. For younger companies in fast-changing industries, predicting future growth with any degree of certainty can be very difficult. Even if an investor can arrive at reasonable growth predictions, the question remains how much they should reasonably pay for that growth.

GARP investors address these uncertainties by using the PEG ratio to determine if a company is reasonably priced given its growth prospects. The PEG ratio is calculated by dividing the P/E ratio by the expected growth rate of a company. A result of one or less indicates that the stock is reasonably priced—a result above one suggests the stock is too expensive.

Take a stock trading at $100 per share, for example, with earnings of $10 per share and an expected growth rate of 20%. This stock would have a PEG ratio of 0.50 ($100 / $10 / 20) and would be considered reasonably priced for a GARP investor.

Compare this to a stock trading at $300 per share, with the same earnings of $10 and expected growth rate of 20%. This stock would have a PEG ratio of 1.5 ($300 / $10 / 20) and be considered too expensive for a GARP investor.

Growth Investing vs. Value Investing

Where growth investing seeks out companies that are growing their revenue, profits or cash flow at a faster-than-average pace, value investingtargets older companies priced below their intrinsic value. GARP investors also use intrinsic value to find growth companies that are attractively priced.

Historically, value investing has outperformed growth investing over the long term.Growth investing, however, has been shown to outperform value investing more recently. One recent article notedthat growth investing had outperformed value investing over the last 25 years. Since 1995, value mutual funds have returned 624%, while growth mutual funds have returned 1,072%.

A look at Vanguard index fundsshows a similar trend. The Vanguard Value Index Fund (VVIAX) has returned on average 6.18% annually since its inception in 2000. In contrast, the Vanguard Growth Index Fund (VIGAX) has returned on average 8.10% annually over the same time period.

The Future of Growth Investing

Some believe the recent trend favoring growth investing will eventually end, with value stocks once again outperforming a growth strategy. It’s certainly true that neither strategy has outlasted the other indefinitely. That said, macro economic trends currently favor growth investing.

Historically low interest rates give growth companies easy access to cheap capital, which is the very lifeblood of fast-growing companies. An increase in the cost of capital could adversely affect these enterprises.

At the same time, Covid-19 may favor tech companies, which often are in growth mode. The pandemic has pushed more shoppers online, aiding businesses like Amazon. And as more and more companies embrace remote work, technology demands increase to sustain this shift. This trend in turn favors high tech companies, pushing stock prices higher.

While these factors may favor growth investing in the near term, nothing lasts forever. The question remains, however, when this trend will come to an end. During the dot-com bubble, the trend ended abruptly, causing severe financial pain for many investors. How and when the current trend will end is unknown.

A Blended Approach: Growth Investing + Value Investing

There’s no need to exclusively pursue a growth investing or value investing strategy. A better way could be to take what’s referred to as a blended approach. A blended investing strategy means you buy companies that fall into both value and growth categories. This can be as easy as investing in an S&P 500 index fund.

The returns you can get by pursuing a blended approach typically lag either a growth or value strategy short term, depending on which is outperforming the other. As such, it can be psychologically difficult to stick to a blended approach when more money is being made either with growth or value investing.

Over the long-term, however, a blended approach can often outperform an investor who switches between growth and value in an attempt to time the market.

Final Thoughts

Growth investing seeks to take advantage of those companies early in their business cycle. Combined with companies in a high-growth industry, a growth investor can benefit as companies grow their revenues, earnings and cash flow. This approach, however, is not without its downside. Growth companies can be very expensive as measured by traditional valuation metrics, such as the PE ratio and BP ratio. In addition, abrupt shifts in market sentiment can send growth company values falling as they did during the dot-com bubble.