It’s been a tumultuous 2021 in the stock market, with the GameStop frenzy, IPO mania, wild electric vehicle (EV) stock valuations, the Evergrande crisis, China’s regulatory crackdowns, and most recently, growth stock pandemonium. Depending on the investments made, you could be in considerable profit or you could be sitting on a major loss; so which investing approach is best for you?
What is value investing?
Value investing is the process of picking stocks that are deemed to be below their ‘intrinsic’ value. This approach primarily focuses on a company’s current financials, but should also take into account its future cash flows and growth expectations, as would be done when researching growth stocks. If you want to learn more about the differences between growth and value stocks, and what to look for, take a look at this article.
What is growth investing?
Growth investors take a different approach; they often seek out the companies of the future. The company may not be generating as much revenue as the big players just yet, but it could have a competitive advantage that could see an entire industry overturned over the course of a few years, capturing more market share and profits over the long run. Amazon v.s. Barnes and Noble or Netflix v.s. Blockbuster, once upon a time being a prime example of growth stocks that succeeded.
Risks and reward of value stocks
Value investing can be classified as a risk-averse stance. Value investors hunt for deals so as not to get ripped off by paying sky-high valuations for companies, so typically, the downside is limited. These companies, once researched appropriately, should be well-capitalized to manage a downturn, and won’t face extreme declines in valuation as a result. The upside, on the other hand, is the gain you get when the market comes back to reality and values the stock fairly, but this can often take years to play out, so patience is key.
Of course, there are geopolitical risks or black swan events with any stock; take Alibaba for example. At an intrinsic value level, the stock is criminally undervalued, but when you take into other factors such as the political climate, and unpredictability, you can see why many investors have decided to steer clear of it.
Risks and rewards of growth stocks
For growth stocks, the upside potential is by and large more attractive to investors, but similarly, an investment can take years to play out. Growth stocks are valued on their future prospects, which means continuous revenue growth, profitability, and expectations of such remain high as a stock grows into its valuation.
So, consequently, these investments can gather a lot of speculation in the markets.
As you can imagine, as more and more capital pours in, speculative bubbles become a side effect with some growth stocks, so you could experience massive drops in the value of your holdings very suddenly. When investing in growth, quality companies with a competitive advantage are a must, and dollar-cost averaging (DCA) is a great solution to the wild price swings that can occur.
Which is the better investment for 2022?
This is purely dependent on your risk tolerance, your time horizon, and the ability to separate emotions from market volatility.
The younger you are, the more likely you are to take risks, so you might want to skew your portfolio towards more growth stocks. If you’re nearer to retirement age, you might decide value stocks are the safer bet as you move your investments to less risky assets.
My personal stance is that everyone should have a mix of both value and growth stocks in their portfolios — just make sure the companies have solid fundamentals. That way, you always limit your downside risk while building a portfolio of mixed-risk stocks.
Financial Writer at MyWallSt
David's favorite stock is Google. He's a daily user of its YouTube platform, where you can learn or find something brand new at the touch of a button. He believes the company will continue to grow for many years to come.