You have probably heard the term growth stock, value stock, or dividend stock before. Have you ever wondered what these terms mean, and how they are different from each other?
A few weeks ago we blogged about market cap, which is a way to measure the value of a publicly traded company. Market cap can be used as one way of diversifying your portfolio by dividing your investments into different classes by the size of the companies you hold. However, it is not the only way to diversify your portfolio. Another way to classify your investments is by what you are trying to achieve with them.
We'll start with growth stocks. These are companies that have a large potential for growth in the near future (hence the name). To find these, look for companies that are growing faster than the overall market (both historically and forward looking). They will devote most of their current revenue to growing the company, have a strong return on equity (ROE) number, and earning per share share (EPS) should be growing as well. These type of stocks can be found in every sector, although some sectors like technology and biotech will have more than others. Growth stocks are more likely found in newer, small cap companies, and can be very volatile, but this is not always the case.
A value stock is a stock that is trading below where it appears that it should be based on the fundamentals of the company. To discover these, you will most likely have to do some financial analysis, or have someone do it for you. Value stocks may have high dividend payout ratios or low financial ratios compared to their peers. For instance, look at price to earnings (P/E) ratios, and a value stock should be in the bottom 10% of all companies. Sometimes value stocks can be good companies that have fallen out of favor for various reasons. Defining a value stock is very subjective, as some people’s value stocks would be considered a bad investment by others. This type of stock is generally considered lower risk than growth stocks, and is more likely found in older, larger companies.
An income stock is a stock that pays dividends that is held for the income it produces. Income stocks typically pay more than CD’s and money markets, and are typically relatively stable in price. Preferred stocks are usually income stocks.One consideration of owning income stocks is that they can be subject to interest rate risk. When rates rise, these stocks typically underperform the market.
A good portfolio will generally hold all 3 of these types of stocks, with heavier weights in one or two of the 3 categories depending on the individual investor and the market conditions. If you want to know more about which type of investments are right for you, please call our office at 904.685.1505 or email us at firstname.lastname@example.org.