3 stock investing strategies: Growth vs. Value vs. Income
If you’re serious about investing, you will come across these terms: growth stocks, value stocks, and income stocks. These three refer to different investing strategies. But say you understand the three strategies. How then do you choose what’s suitable for you? We’ve compiled the information for you.
Growth investing: Picking companies with strong earnings growth prospects
Companies classified as “growth” would typically be:
- Newer companies;
- In younger industries (e.g. technology); and/or
- In emerging markets.
Growth investors would be looking for capital appreciation, which they hope will occur when the companies they invest in grow revenue and earnings rapidly.
By investing in growth companies, you should be prepared to be invested over the medium term at least, to have better chances of seeing the companies’ business expansion programmes turn in higher profits.
The risk is that high-growth companies may spend too much on investment. So they may not have enough funds to sustain them while they’re waiting for their expansion programmes to generate cashflow and profits.
To spot your growth stock opportunities, understand these three factors.
Factors | How? |
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The growth prospects of the companies you follow |
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The competitive challenges they face in achieving growth |
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Whether they can achieve their expansion plans without running into cashflow problems |
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Value investing: Picking companies that are trading significantly below what’s normally regarded as “fair value”
Like growth investing, value investing is also about capital gains. But these companies go about generating it differently. That’s because value investing is about spotting companies which are trading undeservedly at:
- Relatively low price-to-earnings (P/E) ratios,
- Below book value (P/B), or even
- Below cash value.
The key word here is “undeservedly”. Markets are generally quite efficient at pricing stocks. So, you don’t usually get undervalued stocks for no reason.
Sometimes, stocks are cheap because they ran into financial difficulties since the last financial year-end. In such cases, the historical ratios may not be relevant any more.
As such, the challenge of a value investor is, how to determine whether the underlying business is still sound and whether the company can overcome the prevailing difficulties. It’s similar to determining whether an injury is fatal, or a flesh wound that will heal.
Investing in value stocks may require patience, as it sometimes takes many years for value to be restored. Often, a stock becomes undervalued because of transient difficulties which may pass over time.
To spot a genuine value stock opportunity, you need to understand:
Factors | How? |
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Whether these stocks are undervalued relative to similar stocks |
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Whether their undervaluation is due to
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Income investing: Picking stable companies with stable dividends
Key to income investing is picking companies that are generating stable earnings, pay a good amount of their earnings as dividends to their shareholders (good pay-out ratios), and have strong underlying assets or businesses. This sort of companies are typically mature companies.
Contrast this to growth stocks.
“Income” companies | “Value” companies |
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Income investment opportunities are often found in utilities (e.g. telecommunications companies, toll road owners, energy generators) and real estate investment trusts or REITs.
For income investing, you want to look for:
Factors | How? |
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Stability of earnings |
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Pay a good amount of their earnings as dividends to their shareholders |
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Earns you more than the risk-free rate |
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So... Which style/strategy should I use?
The choice often comes down to personal risk appetite and preferences. We summarise the pros and cons for you in this table:
Stock investing strategy | Pros | Cons |
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Value investing |
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Growth investing |
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Income investing |
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So what’s an investor to do? Consider a diversified approach, where you grow your stock portfolio with a mix of growth, value and income stocks.
In other words, don’t put all your eggs in one investment style. And as you diversify, it may be useful to look overseas for investment opportunities, in markets such as the US, Europe, Japan, and Hong Kong.
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