Investing for growth or value
By Suzanna de Baca • Bankrate.com

For many investors, the difference between growth and value investing can initially be confusing, but there are straightforward distinctions to help distinguish between the two. While each style has unique characteristics and often performs differently within various market cycles, many advisers encourage investors to use both strategies within an overall asset allocation to potentially smooth out volatility in a portfolio.

The main difference between growth investing and value investing has to do with the type of company, its earnings, growth expectations and other valuation metrics. This information provides investors with important information on whether the stock is over- or undervalued and gives some idea about future performance.

There are some basic ways to distinguish whether a stock can be characterized as growth or value. Numerous publicly available research reports will give an overview of whether a stock or mutual fund is value- or growth-oriented, so investors don't necessarily have drill into all the quantitative analysis unless they have the desire.

Growth versus value stocks

• Growth: Earnings are expected to grow at an above-average rate compared to the stock's industry or the overall market. Think Peter Lynch of Fidelity. • Value: Lower-than-average price-to-book or price-to-earnings ratios and/or high dividend yields. Think Warren Buffet of Berkshire Hathaway Inc.

Two common valuation measures
Malay Vasavda, principal at Quantum Financial Management LLC in Chicago, explains that there are two main metrics consumers can use to determine the type of stock they are holding: the price-to-equity, or P/E ratio, and the price-to-book, or P/B ratio. P/E ratios are calculated by taking the stock's current price and dividing it by earnings per share. The P/B ratio is calculated by taking the stock's current price and dividing it by its book value. These figures can be found listed with each stock in the newspaper or online. Many times, the ratio is listed and the investor doesn't need to figure it out.

P/E and P/B calculations

Price-to-equity, or P/E: P/E = Stock's current price ÷ Earnings per share Price-to-book, or P/B: P/B = Stock's current price ÷ Book value

These ratios can help determine whether a stock is undervalued or overvalued -- cheap versus expensive. The higher the P/E and P/B ratios compared to other stocks, the more growth-oriented a holding is, and the lower the P/E or P/B, the more value-oriented the stock is.

Valueline, Morningstar and other services also provide this information.

Costly stocks expected to earn their keep
According to Jim Sandager, president of Sandager Advisors, LLC in Des Moines, Iowa, a growth stock is defined as a company whose earnings are expected to grow at an above-average rate compared to its industry or the overall market. These companies may be growing at higher rates than their competitors, and this upward trend can make them attractive to investors even if the share price may appear somewhat expensive.

Daniel Joss, founder of Fox, Joss & Yankee, in Reston, Va., says that a growth stock may be in a rapidly expanding or developing field or industry and may be characterized by quick growth of market share or size of company.

"Think Microsoft or the dot-com companies of the late 1990s," he says.

Dan Danford, principal and founder of Family Investment Center in St. Joseph, Mo., says growth-oriented investments tend to focus on share price momentum.

"In other words, the stock price goes up as investors decide to buy," he says, adding that the consumer may be buying an idea, a new trend, or some favored company, but the share price is usually derived from some speculation about the future.

Growth stocks are often evaluated by investors as outperforming the market as a whole in terms of future earnings growth, says Vasavda, noting that because this expected growth is taken into account, these stocks may cost more relative to their current earnings than others.