Should Investors Buy Growth Stocks or Value Stocks?

We are only at the beginning of 2022, and we have already seen waves of volatility in global financial markets. Treasury yields in the United States are steadily rising in anticipation that the Federal Reserve will likely raise the number of interest rate hikes this year; tensions between Russia and Ukraine has caused chaos in stock markets, causing safe-haven assets to appreciate in value. As if these events weren't bad enough, China's COVID-zero policy is causing problems in supply chains and fueling already rising global consumer prices.

As a result of these developments, investors are shifting their focus from growth to value stocks, dragging the prices of growth stocks down. As the prices of growth stocks are down, it is important for investors to consider whether now is a good time to buy good growth stocks.

Growth stocks versus value stocks

Growth companies are basically businesses expanding their revenues at a quicker pace than that of the average company in their respective sectors. The extraordinary growth of these companies is typically backed by innovative ideas, products, or services that help these businesses tap into existing and new markets. High-growth stocks can be relatively more expensive than average stocks in terms of market multiples such as price to sales and price to earnings. Despite higher multiples and prices, stock traders can earn superior returns if these companies perform well and are able to achieve their potential.

On the other hand, value stocks are associated with those companies that have not been fairly valued by the market. When investors purchase stocks of these companies, they are basically looking to capitalize on the upside potential of the company and book profits when other market participants catch up.

Should you buy the dip in growth stocks?

When we look at the historical trend, we can see that growth stocks have outperformed their counterparts for 11 out of the last 13 years. In addition this track record, the upside potential for such stocks is far greater than value stocks. However, truly capitalizing and reaping good returns may take some time. Also, because growth stocks are more reliant on a vision and expectations of how that vision could disrupt markets, there is a lot of speculation in their valuations. Whenever there is a lot of speculation involved, which isn't backed up by realistic targets, there is a risk of the bubble eventually bursting, resulting in enormous sell-offs.

Having said that, investors can use various metrics to filter out good growth stocks with significant upside potential and benefit from the current stock market situation by getting their pick at discount prices.

How to pick great growth stocks?

When looking for a growth stock, a good strategy is to first examine long-term market trends and then look for companies that are likely to benefit from these trends. The last two years have been a true testament to this approach, as many trends supported by digitalization have been accelerated during this time, resulting in massive revenues and profits for associated companies. Some trends include the rising popularity of e-commerce, which Amazon has effectively catered to; the growth of remote working, which has put Zoom on the map in the last two years; digital advertising and online streaming have gained traction, benefiting Alphabet, Meta and Netflix.

Moving forward, traders should add growth stocks that have a competitive advantage over their rivals, which will most likely keep these stocks from bleeding substantially during market slumps, allowing them to minimize losses. An example of a competitive advantage may be scale benefits like the ones that Amazon enjoys due to its vast global supply chain network that new entrants will find difficult to compete with.

Finally, investors should consider the size of a company's target market and select stocks from companies that still have a long way to go to totally cover their addressable markets. This is because the greater the addressable markets are, the more room there is for the company to grow. Investors can examine a company's growth forecasts, industry size, and market shares using publicly available research studies from businesses such as eMarketer.

Which growth stocks are worth looking at?

The following stocks are a good place to start for stock traders looking to get into investing in growth companies:

• Apple
• Tesla
• Microsoft
• Netflix
• Amazon
• Alphabet
• Airbnb
• Block
• Zoom
• Meta

The bottom line

Given the current stock market situation, where stock prices of growth companies have dipped, investors should at least start researching and looking at growth stocks with a good track record, getting long-term buys at discount prices.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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