There are a number of ways to make money in the stock market. To make money, certain type of investors are attracted to companies that are expected to grow faster in comparison to others by reinvesting most or all of its earnings in themselves. These type of investment strategy is known as growth investing. These investors do not invest to get dividends.
Growth investing is not the only investment strategy for investors to get better returns. Value investing is another well known investment strategy.
Value investment is a strategy in which investors find stocks of companies whose prices do not reflect their true worth or trading far below its fundamental worth, also known as intrinsic value. In other words, these are the stocks that investors believe undervalued by the market but still have a strong potential for upside.
You can identify undervalued stocks by comparing its intrinsic value with the current market price. If intrinsic value is higher in comparison to market price, then the stock is undervalued or else it will be considered as overvalued.
Value investors are always in search for undervalued stocks which offers a margin of safety to invest for a long term. These investors expect the stock to perform well when the market recognizes and corrects the price. On the other hand, in growth investing you will find growth stocks with higher Price to earnings ratio (P/E) and price to book (P/B) ratio.In general, you will never find an undervalued growth stock due to higher expectations of investors.
Growth investors look for companies which has future growth potential with less emphasis on present market price. This means they also buy stocks which are trading higher than their intrinsic value. The main assumption of investing into these companies are that the intrinsic value will grow and ultimately exceed the current valuation.
The biggest problem with growth stock is if it’s not up to investors expectations for a period, then the stock could under-perform in comparison to others when stock market fall.
Investor wants to invest in stocks that are trading below their intrinsic value, where as in growth investing, investors look for long term growth and do not consider intrinsic value for comparison. Therefore, stock price will always be high for a growth stock relative to their sales or profit. Where as in value investing, stock price will be less expensive as market price will be below the company’s fundamental worth.