Two groups of equities couldn't be more different than growth and value stocks. Value stocks are inexpensive, while growth stocks are priced at lofty levels. Investors have not given value stocks the credit they deserve, but they celebrate growth stocks with no guarantee of reward. The primary risk associated with value stocks is that the market values of these companies will never reach their potential, while the danger with growth stocks is that a company's momentum will end before profits are earned.
At first glance, the market value of a stock does not disclose whether an investment represents a value or growth opportunity. By considering the market value of a stock relative to financial fundamentals, including a company's profitability and asset book value, the latter of which is a balance-sheet item that reflects the impact of asset depreciation, value and growth stocks can be identified. Value stocks are cheap based on current or future fundamentals, while growth stocks are more expensive but appear able to continue growing profits at a rapid rate.
Value investors must be patient because it may take time for stocks to reach their anticipated potential. Nonetheless, value stocks traditionally deliver better returns over the long term, according to Brandes Investment Partners data cited in a 2011 article on "The Wall Street Journal" website. This is not always the case, however, as in the five-year period leading up to September 2011, growth stocks did better on an annual basis, generating returns of nearly 4 percent compared with a loss of more than 1 percent in value stocks, based on the article.
An investor's perception of value and growth stocks also plays into the risks surrounding each investment strategy. When the markets are in decline, investors may panic and become more critical of the weaknesses in value stocks, which benefits mature growth stocks. When the markets turnaround, however, sound reason replaces fear and investors are once again able to recognize the opportunity that value stocks present.
Growth stock investors are buying into companies with already proven financial fundamentals. They are willing to pay a premium for those shares in anticipation of continued performance and ultimately expect to profit from the investments. In the event that a growth company fails to deliver on profit expectations, a stock price becomes especially vulnerable to dropping, which would lead to losses for growth investors. Value investors run the risk that the rest of the markets will never recognize the same potential in a stock, in which case profit expectations would not be met.