What are growth stocks and value stocks?

A growth stock is a share in a company whose revenue and earnings are expected to rise much faster than the economy. Investors pay for that future: the price is high relative to today’s profits, and most of the cash goes back into the business instead of out as dividends.

A value stock trades cheaply relative to what the business earns, owns or sells today, usually because growth is slow, the industry is out of favour or the company hit a problem. The bet is that the price undervalues the business and will move toward a fair estimate over time, with dividends paid along the way.

Both labels describe how the market prices a company, not what the company does. Value investing traces back to Benjamin Graham and David Dodd’s Security Analysis (1934) and Graham’s The Intelligent Investor (1949). Philip Fisher’s Common Stocks and Uncommon Profits (1958) became a classic of growth investing, focused on companies able to grow sales for years. The growth investing and Warren Buffett strategy guides go deeper into each school.

Growth vs value stocks: typical traits side by side

The drawing at the top of the page sums up the contrast. Two hypothetical companies make it concrete. Company G trades at $90 a share and earned $2.00 per share over the last year, a P/E of 45; its revenue grew 30% and it pays no dividend. Company V trades at $36 and earned $3.00, a P/E of 12; its revenue grew 3% and it pays $1.08 a year in dividends, a 3% yield.

  • Valuation: growth stocks carry high price-to-earnings and price-to-sales multiples; value stocks carry low multiples of earnings, sales and book value.
  • Dividends: growth companies usually reinvest their profits and pay little or nothing; value companies more often pay a regular dividend.
  • Growth rate: growth companies post fast revenue and earnings growth; value companies grow slowly or are recovering from a setback.
  • Volatility: growth stocks often swing more, because a larger part of their price rests on forecasts that one earnings report can change; value stocks often move less, though a cheap stock can still fall a long way.
  • The bet: for growth, that earnings keep compounding and justify the price; for value, that the price is too low for what the business is worth.

The ratios behind the labels, and how to compute them

Each label rests on a handful of ratios. Learn how each one is computed before you trust it, because a ratio is only as good as the numbers that go into it.

The PEG ratio links the two styles, and the drawing below shows why. Company A trades at a P/E of 40 but grows earnings 40% a year: 40 ÷ 40 = a PEG of 1.0. Company B looks cheaper at a P/E of 20, yet grows only 5%: 20 ÷ 5 = 4.0. Relative to its growth, the “expensive” stock is the cheaper one, if that 40% growth actually happens.

That “if” is the failure case. Say Company A’s growth slows to 10%: at the same P/E of 40, its PEG jumps to 4.0, and a market that paid 40 times earnings for 40% growth may not keep paying it for 10%. PEG also ignores debt, dividends and business quality, so use it as a first filter, not a verdict.

Revenue growth
(Revenue this period − revenue in the same period a year earlier) ÷ the earlier revenue. $130 million against $100 million a year before is 30% growth.
EPS growth
The same calculation on earnings per share (net income ÷ shares outstanding). EPS of $2.40 against $2.00 is 20% growth. Share buybacks can lift EPS even when net income is flat.
P/E ratio
Share price ÷ earnings per share. Trailing P/E uses the last 12 months of reported EPS; forward P/E uses estimates for the next 12 months, which can be wrong. It means nothing when earnings are zero or negative.
PEG ratio
P/E ÷ the expected annual EPS growth rate, written as a whole number: a P/E of 30 with 15% growth gives 30 ÷ 15 = 2.0. It only works when growth is positive and meaningful.
P/S ratio
Market capitalization ÷ the last 12 months of revenue (or price ÷ sales per share). Often used for young companies with little or no profit.
P/B ratio
Share price ÷ book value per share (assets minus liabilities, divided by shares). A classic value measure that misses intangible assets such as software, brands and patents.
Dividend yield
Annual dividends per share ÷ share price: $1.08 ÷ $36 = 3%.
Margins
Gross margin = gross profit ÷ revenue; operating margin = operating income ÷ revenue; net margin = net income ÷ revenue. Rising margins mean each dollar of sales keeps more profit.

Turn your phone sideways to read the drawing. Tap to close.

Two hand-drawn company cards: Company A, P/E 40 and growth 40%, gives a PEG of 1.0; Company B, P/E 20 and growth 5%, gives a PEG of 4.0; a note reads PEG = P/E ÷ growth rate.

How index providers separate growth and value

Style indexes do not pick stocks by feel. They score every company in a parent index on a few measures, then divide the index’s market value between a growth index and a value index. In broad terms:

Two lessons follow. First, growth and value are relative rankings inside an index, not fixed traits. Second, the rules matter: because one family counts price momentum as a growth trait, a stock that fell hard over a year can drift toward the value side at the next rebalance even if its business barely changed. Providers revise their methods from time to time, so check the current methodology before leaning on any label.

  • The S&P style indexes score value on book value, earnings and sales relative to price, and growth on three-year earnings growth, three-year sales growth and 12-month price momentum.
  • The Russell style indexes use one value measure, book-to-price, and two growth measures: a two-year earnings growth forecast and five-year historical sales-per-share growth.
  • In both families, a company that does not clearly fit one style can have its market value split between the growth index and the value index.

Why the line is blurry: GARP and Lynch’s categories

Many investors refuse to pick a side. In his 1992 letter to Berkshire Hathaway shareholders, Warren Buffett wrote that the two approaches are “joined at the hip”: growth is always part of the calculation of what a business is worth, and it can lower that value as well as raise it.

Growth at a reasonable price (GARP) puts this into practice: look for above-average growth, but refuse to pay any price for it. The PEG ratio is its classic tool. Peter Lynch popularized it in One Up on Wall Street (1989), where he wrote that a fairly priced company has a P/E roughly equal to its growth rate, a PEG near 1. That is a rule of thumb, not a law.

Lynch also sorted companies into the six categories in the drawing, and a company can move through them over its life: a fast grower matures into a stalwart, then a slow grower. A cyclical can look cheapest on a low P/E right at its earnings peak, just before profits fall. The Peter Lynch strategy guide covers each category.

Turn your phone sideways to read the drawing. Tap to close.

Six small hand-drawn boxes in two rows, each with a mini price doodle: slow growers (flat), stalwarts (steady rise), fast growers (steep rise), cyclicals (waves), turnarounds (a fall then a recovery) and asset plays (flat, with a hidden $ box).

How interest rates affect growth valuations

A stock’s value can be seen as what all the cash it will produce is worth today. To bring future cash back to today, you discount it at a rate that rises with interest rates, and the further away the cash, the more that rate matters.

Pure arithmetic, no forecast: $100 due in one year is worth $96.15 today at a 4% discount rate and $94.34 at 6%, about 2% less. $100 due in ten years is worth $67.56 at 4% and $55.84 at 6%, about 17% less. A growth company whose profits lie mostly years ahead behaves like the ten-year cash; a mature company paying dividends now looks more like the one-year cash.

That is why growth stocks are often called long-duration assets and are commonly said to be more sensitive to interest rates. In practice rates are only one input: they often move with growth and inflation expectations, and the link does not hold every time. Nobody can tell you what rates will do next, and this guide does not try.

Value traps: cheap for a reason

Value investing rests on Graham’s margin of safety: buy well below a conservative estimate of what the business is worth, so a mistake in the estimate does not sink you. Margin of safety = (estimated value − price) ÷ estimated value.

Working case, hypothetical: you estimate Company C is worth $50 a share, and it trades at $35, a 30% margin of safety. A temporary problem has scared buyers off; the business steadies, and the price drifts back toward the value line, as in the drawing.

Failure case, same company: revenue is falling 8% a year as customers leave for a newer product. At $35 the P/E is 7 on EPS of $5.00, with a 7% dividend yield. A year later EPS drops to $3.00 and the dividend is halved. Your $50 estimate becomes $30, so the margin was never there, and the stock slides to $24, still only 8 times earnings, for a 31% loss before dividends. That is a value trap: a low multiple on shrinking earnings.

  • Revenue and margins falling year after year, not just for one quarter.
  • Debt rising, or a dividend larger than earnings (a payout ratio above 100%).
  • An industry losing customers to a new technology.
  • A low P/E built on peak earnings, as with cyclicals at the top.

Turn your phone sideways to read the drawing. Tap to close.

A dashed horizontal line labeled intrinsic value (estimate) and a wavy price line crossing above and below it; where price sits far below the line, the gap is shaded and labeled margin of safety, with a buy triangle; a note reads value is an estimate.

Growth traps: a great company at too high a price

The growth trap is the mirror image: the business delivers, but you paid for more than it could deliver. The drawing shows it: earnings rise every year while the share price falls, because the P/E shrinks from 60 to 25.

Hypothetical Company D trades at $120 on EPS of $2.00, a P/E of 60. Over three years EPS grows 20% a year to about $3.46, an excellent result. But the market decides 25 times earnings is enough: 25 × $3.46 ≈ $86, a 28% loss while the company did everything right. Had growth also slowed, the earnings line and the multiple would have fallen together.

Warning signs: a P/E or P/S far above the growth rate, a price that assumes years of flawless execution, slowing revenue growth hidden by one-off gains, and heavy share issuance that dilutes EPS. The how to pick growth stocks guide shows how to check the earnings behind the story.

Turn your phone sideways to read the drawing. Tap to close.

Two lines over the same years: EPS rising steadily in green while the share price falls in red, with a P/E 60 tag at the start, a P/E 25 tag at the end and a note reading great company, too high a price.

Growth vs value investing: how a beginner can mix both

You do not have to choose. A broad market index fund already holds both styles in proportion to their size, which is the simplest mix. If you want a tilt or individual stocks, write the plan down before you buy and keep each position small enough that one mistake cannot sink the whole.

Whatever the mix, results vary, any single stock can lose a large part of its value, and past style trends do not predict the next ones. The risk management guide covers limits like these in more depth.

  1. Set a target mix: for example, a hypothetical 50% growth and 50% value, or a broad index as the core with a smaller slice in individual stocks.
  2. Diversify within each style: growth stocks and value stocks can each cluster in a few industries, so a one-style portfolio may be less diversified than it looks.
  3. Size every single stock: for example, no more than 5% of the portfolio in one name, so a value trap or a growth trap stays a bruise.
  4. Write the exit rule on day one: a broken thesis (revenue falling two quarters in a row for a growth pick, a dividend cut for a value pick), or a price stop if you use one.
  5. Wait for confirmation before adding: add only after the next earnings report supports the thesis, not because the price moved.
  6. Rebalance on a schedule: hypothetically, $10,000 split $5,000 / $5,000 becomes $6,000 growth and $4,800 value; back to 50/50 means moving $600 from growth to value.