What Are the Risks Associated With Investing in an Income Stock Vs. a Growth Stock?
Income and growth stocks offer investors ways to identify potential profit opportunities, but they also present their share of risks. Investors are seeking profits from both, but they turn to each investment type with different strategies in mind. Income stocks normally offer a steady income stream that can help to balance an investment portfolio against volatility. Growth stocks are expected to continually grow earnings, and their market values are similarly expected to rise. If these companies fail to deliver on expectations, investors can be left with nothing.
Dividend-paying companies are income stocks because they provide a relatively steady flow of revenues to investors. As long as these companies continue to generate cash flow, they have a source from which to pay dividends to investors every quarter or year. Investors have no guarantee of this income, but there are companies that have a history of paying and raising their dividend distributions. Growth stocks have high valuations relative to future earning estimates, which makes them expensive, but investors are betting that profit growth will continue.
Dividend stocks are comparable to fixed-income securities, which are bonds. Like bonds, income stocks pay cash distributions to investors, often like clockwork. Unlike bond issuers, companies offering income stocks are not obligated to make those payments. If cash flow slows or the company needs to reinvest earnings into the business, the income can stop. Growth stocks are often compared with value stocks, which are relatively inexpensive and based on future potential profits. Investors pay a premium price for growth stocks based on a company's earnings momentum, and have more at stake if the investment loses value.
Earnings are a risk for income stocks not only because they have the potential to influence market values but also because they are the source of dividend payments. If a company does not have extra profits from which to maintain or increase dividends, income can be interrupted. Growth stocks are susceptible to earnings but for different reasons. Growth investing is built around the presumption that there is profit growth in a company's future, and without earnings performance the entire strategy weakens.
Declining market values are a risk for any type of stocks, including income and growth securities. Falling stock prices can often be more difficult to notice in an income stock. An investor can become dependent on the income stream and place less significance on the stock price, but the merits of a stock's dividend can be erased if the market value drops far enough, according to a 2012 MSN Money article. Growth stock performance is dependent on earnings, and these investments are especially vulnerable to disappointments. The slightest unwanted development could send the market values of growth stocks lower, according to a 2011article on the Axa Equitable website.
Geri Terzo is a business writer with more than 15 years of experience on Wall Street. Throughout her career, she has contributed to the two major cable business networks in segment production and chief-booking capacities and has reported for several major trade publications including "IDD Magazine," "Infrastructure Investor" and MandateWire of the "Financial Times." She works as a journalist who has contributed to The Motley Fool and InvestorPlace. Terzo is a graduate of Campbell University, where she earned a Bachelor of Arts in mass communication.