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Value shares trade at low prices, but typically have limited growth prospects. Growth stocks have brighter future opportunities, but are usually more expensive.
Which is better? The boring answer is that it depends on the individual, but I think there’s a fun way to tell whether someone is better suited to growth stocks or value shares.
A test case
I think CostCo Wholesale (NASDAQ:COST) is a terrific case study. A £10,000 investment in the stock five years ago would be worth £32,578 today and the rising share price is no accident.
The company is a retailer with an almost unreasonable focus on low prices. And it has a number of advantages that allow it to do this without undermining its own profitability.
These include the company’s membership scheme, its limited product range, and the layout of its stores. Together, these put CostCo in a powerful commercial position.
Despite this, investors are wary about buying the stock at the moment. And the reasons why help illustrate the difference between growth investors and value investors.
Growth vs value
One reason to hesitate when considering CostCo is its growth. Sales have grown by an average of 7% per year over the last 10 years, but this could be difficult to maintain.
On average, the company opens around 25 warehouse stores each year. But this makes less of a difference with the store count at 876 than it was in 2012, when it had 608 outlets.
Another reason for caution is price. The stock currently trades at a price-to-earnings (P/E) ratio of 51, which is very high and implies an earnings yield of just under 2%.
Even for a company as strong as CostCo, it’s difficult to find this attractive when a 10-year government bond offers an annual yield above 4%. So valuation is also a potential issue.
Which is more important?
Both are good reasons, but which matters more? I think the answer investors give goes some way towards indicating whether they should focus on growth stocks or value shares.
Investors most concerned with revenue growth should probably focus on growth stocks. There are several companies that are likely to grow sales by more than 7% per year in future.
By contrast, those who think the biggest issue is a P/E ratio of 50 are likely to do better with value shares. Plenty of stocks trading at P/E multiples below 15 are worth a look right now.
In my view, neither is entirely right or wrong. That means I probably don’t neatly fall into either category of investor, so what should I do to try and find stocks to buy?
Investing £10,000
If I were investing £10,000 today, I’d try to listen to Warren Buffett’s advice. The best investors, according to the Berkshire Hathaway CEO consider both growth and value.
Put simply, they focus on buying stocks for less than they’re worth. But how much they’re worth is determined by their future growth prospects.
I think there are a number of stocks that fit the bill right now – some growth stocks and some value shares. So it’s a good time for investors like me at the moment.
