Growth vs. value stocks
One question you can ask yourself before you invest in a company: why do I think the value will increase and provide a good return on my investment?
One reason is because the company is poised to grow at a rate above the overall market. These are called growth stocks.
Another reason is because the company is valued lower than it should be right now based upon a fundamental analysis of its fair market value. These are called value stocks.
Growth
With a growth stock, the current price may already be high due to strong demand, because people think the stock will be worth much more in the future. That is the risk you are taking, because if the stock does not outperform the overall market, you are now behind.
Having a good knowledge of the market in which a growth stock company operates is very helpful. There may be market disruptions (AI anyone?) that lead to outsized expected growth. Look at Nvidia’s 5 year chart. Tell me when everybody figured out Nvidia’s chips were amazing for AI processing.
Or Amazon during the pandemic. Look at this chart and tell me when everybody figured out that if you can’t go to the store to buy things, you are going to need to order it online.
These companies were sitting in a market that, for whatever reason, had amazing growth potential. The companies were able to use their core strengths to jump ahead of the overall economy in terms of value creation speed.
Value
As mentioned, value stocks are those that, after lots of research into the company and market itself, you think the price of the stock should be higher than it is right now. And you expect that stock price to rise as everybody else realizes all the amazing things you already realized.
The stock could have been beaten down by some newsworthy event, which caused everybody to panic sell. These stocks are trading nowhere near their high marks. However, if you think the stock will get back up to that high water mark, you may have found a good value stock.
Now, determining which stocks that have suddenly dropped in value are actually value stocks takes research. You don’t want to “catch a falling knife” by the blade and end up bloody. You want to be able to catch the handle! Does the company have enough cash to weather any storm? Are creditors piling up? Is the photograph printing market shrinking incredibly fast and the company is not making the right decisions? Back to that fundamental analysis of the company itself - if you look at the financials and are impressed with the leadership's team ability to navigate that quick drop in stock value, then you found a winner!
Warren Buffet seems to think United Health is a value stock. As you can see, the stock is about half of its initial value. Buffet is in this for the long term and is hoping that his research is correct in terms of UnitedHealth potentially doubling back up to its previous value faster than the market as a whole would double. Either that, or he hopes his clout is enough to make it a value stock in that more people will invest just because he did.
Holy cow done
That about wraps up the difference between these two types of stocks. Many stocks are a blend of the two, also. But seeing the extremes helps with understanding this way to differentiate stocks. Yes, there are more specifics that I didn't fully get into. And yes I am trying to be as approachable as possible with the topic. Hopefully this helped you!
Can you find an example of a potential value stock out in the world currently? How about a potential growth stock?
For people who don't think they have an edge over professional investors, I propose a third thing: the index fund, where you put most of the money and let it follow the market as a whole, which makes your retirement investments as secure as the market as a whole. And then your investment in value or growth stocks can be smaller bets for the dopamine rather than having our ability to retire be based on your ability to outdo professionals at their own game. I'm not going to say that some people didn't have the right information to buy or sell ahead of the crowd, but for every buyer there's a seller. You've got to be very good to be consistently on the right side of that trade, and most people aren't.
The context of this post is that some are interested in learning about investing (other than the standard good advice of sticking the vast majority in an ETF). See this post.
What you say is of course true, and it is wise for the vast majority of your investments to be in a well diversified ETF, this is for those who are interested in learning about other aspects.
The other aspect re: can’t out perform professional traders- you can’t if you try to do their job and trade over multiple big assets in multiple industries you know little about. As an individual investor your edge comes from investing in things your unique life experience gives you a strong signal is going to cause a change in an industry you know well and ignoring the rest (unlike the professional investor, you can choose not to play if there are no good moves).
That's generally the best idea for long-term investment, but even many avid ETF-only investors have like 5% of their portfolio in individual stocks, just because it can be much more fun and engaging that way
To expand on value investing, the idea is that you calculate what a company is worth based on fundamentals like what assets and debts it has and how profitable it is now. This process is called "fundamental analysis" and the result is called the "intrinsic value." Only then do you see if the stock price is lower than expected. This is a way to try to identify bargain prices.
There will still be subjective judgement calls, but not as much as if you're also taking into account how much the company might grow in the future.
For many stocks (particularly technology stocks), the stock market is a lot more future-oriented - people are trying to guess what a company will be worth many years in the future and pricing it based on that. The prices on these stocks will look way too high to anyone doing fundamental analysis. No bargains there!
True bargains are harder to find these days because investing in value stocks is a well-known approach. A stock that looks like a bargain according to fundamental analysis is one that the stock market thinks has something wrong with it. You need to figure out why and then decide whether you still disagree about the price.
If you're not looking at the financial statements, understanding the business, and figuring out what the company should be worth (or relying on the opinions of people who do that) then you're not doing fundamental analysis. Most amateur investors aren't that interested in doing this homework. It's something I've always been too lazy to do myself.
The Amazon graph is interesting. The outcome that online ordering would likely increase in a lock down/pandemic situation was fairly obvious in hindsight at least, but the share price took some time to take off. I wonder if this attenuated by concerns over supply chains crumbling around that time as well?