Once retirement assets begin to build, many dentists have questions on the most effective strategies for investing. So, it’s important to understand a key distinction in equity investing, growth and value. Understanding these styles of equity investment will enable you to determine the impact they may have on your investment objectives. These equity investment choices should be considered along with assessing your risk tolerance, investment objectives and your retirement horizon.
Growth and value are two fundamental approaches in stock and mutual fund investing. Many growth stock mutual fund managers look for stocks of companies that they believe offer strong earnings growth potential, while value fund managers look for stocks that appear undervalued by the marketplace. Some fund managers combine the two approaches.
How to identify growth and value stocks
Although earnings of some companies may be depressed during periods of slower economic growth, growth companies generally seek to achieve high earnings growth regardless of economic conditions. “Emerging” growth companies are those that may have the potential to achieve high earnings growth but have not yet established a history of strong earnings growth.
Value stocks are those that generally have fallen out of favor in the marketplace and are considered bargain priced compared with book value, replacement value or liquidation value. Typically, value stocks are priced much lower than stocks of similar companies in the same industry. This lower price may reflect investor reaction to recent company problems, such as disappointing earnings, negative publicity or legal problems, all of which may raise doubts about the company’s long-term prospects. The value group may also include stocks of new companies that have not been recognized by investors.
The primary measures used to define growth and value stocks are the price-to-earnings ratio (the price of a stock divided by the current year’s earnings per share) and the price-to-book ratio (share price divided by book value per share). Growth stocks usually have high price-to-earnings and price-to-book ratios, which means that these stocks are relatively high-priced in compared with a company’s net asset values. In contrast, value stocks have relatively low price-to-earnings and price-to-book ratios.
Features of growth and value stocks
- Higher priced than broader market
- High earnings growth records*
- Less sensitive to economic conditions than broader market
- Lower priced than broader market
- Lower priced below than similar companies in industry
- Higher risk than broader market
*Past performance is not indicative of future results.
Growth and value: Complementary investment styles
Following a specific investment style, such as growth or value, provides investment managers with guidelines for choosing stocks. Growth fund managers look for high-quality, successful companies that have posted strong performances and are expected to continue to do well, although there are no guarantees. Of course, there is no assurance that this forecast will be attained. Investors are willing to pay high price-to-earnings multiples for these stocks in expectation of selling them at even higher prices as the companies continue to grow. The risk in buying a given growth stock is that its lofty price could fall sharply on any negative news about the company, particularly if earnings disappoint Wall Street.
On the other side, value fund managers look for companies that have fallen out of favor but still have good fundamentals. They buy these stocks at prices below the stocks’ average historic levels or below the current levels in their industry groups. Many value investors believe that stocks become value stocks when investors overreact to negative events. The idea behind value investing is that stocks of good companies may bounce back in time when the true value is recognized by other investors. But this recognition of value may take time to emerge and, in some cases, may never materialize.
Which strategy — growth or value — is likely to have higher return potential over the long term? The battle between growth and value investing has been going on for years, with each side offering statistics to support its arguments. Some studies show that value investing has outperformed growth over extended periods on a value-adjusted basis. Value investors argue that a short-term focus can often push stock prices to low levels, which, in turn, can create great buying opportunities for value investors.
Manage risk by combining growth and value
Mutual funds are a popular choice as a retirement plan investment option. For many mutual fund investors, however, there may not be an absolute advantage to any single approach to investing over a long period. Instead of choosing only one approach, individual investors may strive for the best possible returns while managing risk by combining growth and value investing. This approach allows investors to potentially gain throughout economic cycles in which general market situations favor either the growth or value investment style.
For example, value stocks, often stocks of companies in cyclical industries, generally tend to do well early in an economic recovery, while growth stocks tend to lead bull markets, which are normally fueled by falling interest rates and increased company earnings. Also, because the two groups of stocks tend not to move in the same direction or to the same extent, investors can potentially enhance returns and manage risk by combining the two approaches.
Mr. LoPorto is senior director and client relationship manager at AXA Equitable. He has more than 25 years of experience in the retirement and financial services industry.
This article has been written for general information purposes only. This material does not constitute an offer or solicitation of any kind and is not intended, and should not be relied upon, as investment, tax, legal, or financial advice or services.
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The ADA Members Retirement Program is here to help
As you review this article, keep in mind there are many points to consider. You may want to evaluate your and your practice’s unique needs and goals. For these reasons, it is generally advisable to speak with a retirement planning professional before making any decisions. The ADA Members Retirement Program is endorsed by the ADA to help dentists and their employees regarding retirement planning.
The ADA endorses retirement savings and distribution plan products through AXA Equitable that can assist you toward achieving your retirement goals. With more than 50 years of experience working with ADA members, AXA Equitable retirement program specialists are licensed to provide the expertise and resources to assist you and your dental team evaluate the plan options best suited for your personal retirement goals. In addition, AXA Equitable provides a full range of recordkeeping and plan administration services to complement its suite of retirement products for ADA members and their employees.
For additional information on these ADA-endorsed member benefits, call AXA Equitable at 1.800.523.1125 or visit www.axa.com/ada to learn how you can start saving today!