For those new to investing, the terms value stocks and growth stocks are what you will hear every other day as you decide what stock to buy, sell or hold.
Stocks, just like most investments are thrown into buckets to enable investors understand the peculiarity of each asset and decide where one’s risk appetite lies.
In this article, we shall explain the difference between Growth Stocks and Value Stocks as it pertains to investing in the Nigerian Stock Market.
These are stocks of quoted companies that are in the early stages of their business cycles, characterized by phenomenal growth in revenues. Growth stocks typically post double digit revenue growth periodically (annually in Nigeria) and it doesn’t matter if they report profits or not. In fact, most growth stocks are expected to report losses because it is expected that they spend a lot more on marketing, advertising and anything that is required to scale up their operations.
Due to this, growth stocks always attract expensive valuations and are often priced at over 50 times their earnings (if they have one). They also do not necessarily pay dividends as investors bet against their ability to grow top line revenue exponentially and reward this expectation with high valuation. Bottom line, they feel these stocks will come through some day.
It is hard to find growth stocks in the Nigerian Stock Exchange because growth stocks are mostly found in the tech space. Investors also often misconstrue growth stocks with stocks that are considered bull traps. Stocks that attract high valuation despite not posting any results or have any inkling of a solid business operation.
However, a stock that may have been considered as a growth stock a few years ago was Forte Oil. Between 2013 and 2015, investors bet that the new management will turn the company around rapidly and valued the stock as high as 90 times its earnings at some point. The company tried to match these expectations by churning double digit profitability growth before the economy got into trouble, slowing down its growth.
A stock like Dangote Flour Mills can also be considered a growth stock. Ever since Dangote Group took it back from Tiger Branded, they have embarked on a massive turnaround that has seen the company report back to back profits for the first time in years. Investors have rewarded the company with higher valuation multiples. More so, the stock is still trading at very low valuation multiples, perhaps as investors wait to see if it can generate enough growth to clear out its accumulated losses of about N6 billion.
Growth stocks generally have high Price-to-earnings (P/E) ratios and high Price-to-book ratios, and are sometimes seen as expensive and overvalued.
These are stocks that have attained a considerable level of maturity in their business life cycle. They are stable, less risky and post moderate but steady revenue growth, profits and always pay dividends. These attributes are often referred to as strong fundamentals for any company who possesses them.
Value Stocks tend to trade at a lower price relative to their fundamentals (including dividends, earnings, and sales). Due to their low price to earnings ratio, investors often see them as bargain stocks and acquire them in the hope that the market will soon realise that they are undervalued. When this happens, the share price of these stocks start to rise relative to new information pertaining to its profits and/or dividend announcements.
For example, in the last two years since Nigeria faced economic crisis, banking stocks, particularly the FUGAZ, have traded at price earnings ratio of below 3x their earnings. Investors feared that they might post losses on the back of a poor economy and as such assigned low earning multiples to their valuation. However, as results poured out showing record profits instead of declines, investors now realised indeed that these stocks are worth more than they currently are. Value investors are expected have acquired shares in the stock because they know that their fundamentals are sound and will be rewarded when the time comes.
Sometimes, Value Stocks may have prices that are below the stocks historic levels or may be associated with new companies that aren’t recognized by investors. They may also have been affected by a problem that raises some concerns about their long-term prospects – such as recently poor operating results and negative outlook.
Another example, is just before the investor/exporter window was introduced, the stock market assigned very low price earning multiples to Nigerian Stocks. This is despite signs that the economy was turning around. Eagle eyed value investors always see these signs and quickly buy the stocks. Value Stocks usually have low P/E ratios and low Price/book ratios.
Summary of the differences between Growth and Value Stocks
- A Value Stock is cheap relative to some measure of its intrinsic value. Value Stocks are companies that are undervalued, and are out of favour with the market due to poor operating results and or slowing growth. Due to the gloomy nature and negative outlook of these stocks, investors overreact and Value them lower than they should be.
- Growth stocks are overvalued with recently great operating results and fast rising growth. Investors overreact to these stocks and Value them higher than they should be.
Note: Growth and Value Stocks are styles of investing in stocks. Neither approach is guaranteed to provide appreciation in stock market value as both carry investment risk.