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By Will Ashworth
last updated
The concept of "growth" vs "value" is one that's ingrained in most investors' minds. The best growth stocks are those exciting businesses whose revenue is expanding at a seemingly exponential pace, whereas value stocks are those that have steady, reliable growth.
The question rookie investors should ask themselves isn't which style is better, but rather why each style matters. Perhaps more importantly, folks should be researching how to successfully integrate them into their overall investment strategy.
In recent years, the advent of the exchange-traded fund (ETF) has made it much easier to invest in both growth and value stocks.
For example, BlackRock offers both the iShares S&P 500 Growth ETF (IVW) and the iShares S&P 500 Value ETF (IVE), which gives you a tiny slice of exposure to hundreds of stocks in each category – all for pennies on the dollar.
But this article isn't about finding the best ETFs to buy, rather it's one about how to find the best growth stocks to buy, so put these funds aside. We'll revisit them later in the story.
For now, let's consider what defines growth stocks.
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What are growth stocks?
Interestingly, the idea of growth and value has only existed for about 30 years. In 1992, two finance professors, Eugene Fama and Kenneth French, at the University of Chicago's Booth School of Business introduced their Three-Factor Model, which helped explain alpha, the investment return above the market or benchmark index.
"Fama and French defined value stocks as those equities that have high book-to-market-value ratios, and growth stocks as those that have low book-to-market-value ratios," wrote Simona Gambarini, senior market strategist at Goldman Sachs Asset Management, in an April 2023 article.
The idea is that value stocks are those companies whose share prices trade below their "intrinsic" or book value. In contrast, growth stocks increase their value by generating higher cash flow over time, thus generating a better return on assets.
That being said, like pronouncing "tomato," every investor, professional, or do-it-yourselfer has a slightly different definition. And that's okay.
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Why should I invest in growth stocks?
Since Fama and French developed this idea, investors have argued over which investing style delivers the best returns. The truth is, they both do, but at different times in market cycles.
Between January 1970 and February 2007, value stocks outperformed growth by 7.1% annually, Gambarini's data shows. Then, growth stocks outperformed value for the next 13 or so years, between March 2007 and September 2020.
Many experts believe chasing style by timing the market is a losing proposition. A better approach is to include the best stocks from both growth and value in your portfolio, creating a more blended and balanced composition.
While it's beneficial to create a portfolio that balances both investing styles, there are times when you'll want to amp up your risk/reward profile, and finding the best growth stocks is an excellent way to do that.
In his feature, The 30 Best Stocks of the Past 30 Years, Dan Burrows, senior investing writer at Kiplinger, highlights a study that details the performance of 64,000 global stocks over 30 years between January 1990 and December 2020. The data, courtesy of Hendrik Bessembinder, a finance professor at the W.P. Carey School of Business at Arizona State University, found that over 50% of these stocks underperformed risk-free one-month U.S. Treasury bills.
Data points like this might make you think twice about investing in growth stocks. Don't give into the fear. Growth stocks can deliver alpha for your portfolio over the long haul when used responsibly. Indeed, the IVW growth ETF mentioned earlier has averaged an annual total return (price change + dividends) of 16.7% over the past 15 years, beating the S&P 500's total return of 15.8%.
Care to guess the top-performing stock over 30 years?
Apple (AAPL) with an annualized dollar-weighted return of 23.5%, creating $2.67 trillion of wealth for investors. If you invested $10,000 in 1990, it was worth $5.62 million in December 2020. Risk is relative to reward.
So, how do you find growth stocks like Apple? Read on, and we'll show you.
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How to find the best growth stocks?
Now that we've figured out what growth stocks are and why you should own them, it's time to find some options worthy of you investing your hard-earnings cash in.
While there are many avenues to research growth stocks, these are three of the most common methods.
Use a stock screener to narrow the possibilities. I use the screener provided by S&P Global Market Intelligence as part of my S&P/Capital IQ paid subscription. The service allows users to search U.S. and global stocks of all sizes and growth profiles based on various metrics.
However, there are ample free stock screeners available to investors, including those from Morningstar, Yahoo Finance, and Investing.com. You'll want to narrow the field using financial metrics such as return on assets, earnings per share growth, higher price-to-sales and price-to-cash-flow ratios.
Yahoo Finance has several preset screens with growth-focused ideas, including one for growth technology stocks and another for undervalued growth stocks, a riff on blended stocks.
Scour the holdings from the best growth ETFs. This could include the BlackRock fund (IVW) mentioned earlier. It tracks the performance of the S&P 500 Growth Index, which represents 53% of the market cap of the S&P 500.
The index selects the stocks from the S&P 500 with growth characteristics such as the "three-year change in earnings per share over price per share, three-year sales-per-share growth rate and momentum (12-month percentage share price change)," states the IVW summary prospectus.
The fund's fact sheet is an excellent place to find basic information such as its top 10 holdings, top sector weightings, and fund characteristics. Apple is currently the largest holding in IVW with a 13.2% weighting, with Microsoft (MSFT) a close second at 13.1%.
If you want to sample other growth ETFs, data analytics provider VettaFi provides a comprehensive list of funds available based on various criteria, including net assets.
Google keyword strings that describe what you're looking for. The most straightforward is "growth stocks to buy." This search generated nearly 2 million results, many of which can provide a jumping off point for your research.
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The bottom line on growth stocks
Finding quality growth stocks isn't easy. It takes time.
By using these three methods to screen for the best growth stocks and developing other techniques, you can eventually unearth hidden gems more quickly.
However, finding the names is only the beginning.
The hard part is evaluating whether the business is worth investing in over the long haul. That requires learning about the business model, its financial situation and anything else that might influence its share price in the future.
Warren Buffett's advice wouldn't be for most folks to stick to low-cost S&P 500 ETFs and mutual funds if investing were easy.
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Will Ashworth
Contributing Writer, Kiplinger.com
Will has written professionally for investment and finance publications in both the U.S. and Canada since 2004. A native of Toronto, Canada, his sole objective is to help people become better and more informed investors. Fascinated by how companies make money, he's a keen student of business history. Married and now living in Halifax, Nova Scotia, he's also got an interest in equity and debt crowdfunding.
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