While definitions of small, mid, and large capitalization stocks are largely agreed upon, the definitions of growth and value differ, sometimes dramatically, across the investment and asset management industry.
Broadly speaking, growth stocks have demonstrated stronger-than-average earnings growth in the past, a trend that is expected by stock analysts to continue. Value stocks, on the other hand, tend to be those that have fallen out of favor, meaning their share prices have likely dropped off and investors believe the situation to be temporary. Those general classifications lead to distinct characteristics across an overall portfolio even if the classification of a small handful of stocks differs between investment managers or index providers.
Growth stocks tend to have valuations (price/earnings) that are higher than the broader market (for large and mid-cap stocks, the Russell 1000 Index is a good guide-post) because investors are willing to pay a higher price for above-average future earnings growth potential. Because value stocks have typically fallen out of favor (or have been left behind during a market growth spurt), their valuations tend to be lower than the overall market. Investors here need more enticement to purchase the stocks of companies whose future growth prospects are less clear. The most commonly used valuation techniques in addition to price/earnings are price/sales and price/book value (an accounting metric). Some value-focused managers also use a price/intrinsic value metric, which compares a stock’s current price to the manager’s perceived value of a company if the entire company was sold to a private buyer.
Like their names suggest, growth stocks should have higher future and historical growth rates (earnings, sales, cashflow, etc.) compared to the overall market. Value stocks tend to, but not always, have both lower historical and expected growth rates.
Overall, value stocks tend to have higher yields (dividends per share/share price) than growth stocks, primarily because those companies don’t need as much of their profits to fund future growth through expansion, acquisitions, etc. and are more likely to pay out profits and cashflow as a dividend to stockholders. Growth companies, in contrast, tend to pay lower dividends, or no dividend at all, as they are typically in a growth phase, and use available cash to fund expansion and re-investment in their business. But remember not all value stocks pay dividends, and many growth stocks do pay dividends, often as a sign of confidence in their future growth prospects, and that they will be able to fund future growth initiatives from future profits.
Other factors also vary among growth and value stocks, but the three discussed above are the most prominent. Because certain firms tend to exhibit similar characteristics, sector biases develop in growth and value fund and ETF investments. The Russell indexes are a popular domestic equity index family that capture both size and style combinations of the stock market. As mentioned above, the Russell 1000 Index includes the largest domestic stocks, while the Russell 2000 includes smaller domestic stocks. The chart below shows the sector allocations as of June 2019 for each of the growth and value indexes.