I wish I knew what growth and value were, but I’m too embarrassed to ask

Investors in stocks can follow a number of distinctively different approaches – often referred to as styles – when deciding which companies to buy. The two styles that are most frequently used to classify investors are growth and value.

Growth investors look for companies that are expected to grow their earnings faster than their sector or the wider market. They will often be willing to buy shares on valuations that appear quite high compared to other companies if they believe that these may be justified by future profits. This approach places more emphasis on the firm’s potential, as opposed to its current financial situation.

Value investing is the opposite. Value investors focus on companies that appear to be cheap today (or sometimes stocks that should be cheap in the very near future if the business recovers after a recession or crisis). While growth investors are typically mostly concerned with earnings, value investors will often look for stocks that trade at a discount to book value (assets minus liabilities) or offer high dividend yields.

Some investors view the distinction between growth and value as artificial. A successful growth investor still needs to be confident that a company is not so overvalued that its earnings can’t justify the price they are paying. A value investor needs to consider whether a stock is cheap because the underlying fundamentals of the business are faltering and will lead to reduced profits, financial distress or bankruptcy in future.

That said, growth versus value provides an easy way to divide the market into stocks that are popular and high-priced and those that are out of favour and trade on lower valuations. Historically, the value segment of most markets have tended to beat the growth segment over the long run (which may be attributed to exuberant investors overvaluing potential growth). However, in the past decade, growth has handily beaten value.