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YahooU: Value vs. Growth Stocks

Yahoo Finance's Brian Cheung breaks down the difference between value stocks and growth stocks.

Video Transcript

ZACK GUZMAN: Welcome back to Yahoo Finance Live. This week if you've been watching, we've been talking a lot about this so-called rotation away from some growth names into cyclical or value names here. And that might raise questions since you both hope both are going to go up if you're trying to invest here. Stocks should grow.

So what do we really mean by that? Here to break that down in Yahoo U with us today is Yahoo Finance's Brian Cheung. So, Brian, explain this one for us.

BRIAN CHEUNG: Well, Zack, class is in session, and value versus growth. Now, of course, as people we'd like to have both, but in the investing world, they're often distinctively used to refer to a stock's profile. And lately you've heard that growth investing has been dramatically outperforming value. Some of that changed as the vaccine developments came off.

But first off, it's important to note that there is no MBA definition for what defines a value versus a growth stock, but there are general characteristics that can help us identify growth versus value.

So let's start off with growth first. So what you're looking at here is some basic kind of characteristics in a growth stock, if you will, right? So generally, growth stocks tend to have higher upside potential, which can be measured as things like expectations for revenue growth or earnings in the future. But then you also have something that's not so great, little to no dividends, and that's usually because it's an early-stage company. They don't have reliable cash flow. So you might not be getting that in a growth stock. And lastly, these types of stocks, especially as of late, tend to be pretty expensive to own.

So a good way to think of all this is almost like a sports car, a Corvette if you will, right? It's a fun ride if you like the thrill seeking, but it's not the most reliable vehicle, and it's also going to cost you a pretty penny.

Now that means that value stocks are like the Toyota Camrys, that Kia Rios of the world, if you will, right? They're not sexy, but it's reliable, and it's going to last a while, and they'll help you stretch your dollar. You can pass it down to your kids. These stocks tend to have lower expectations for future growth, but what they lack in explosive growth, they're going to make that up in history, right? They have a storied reputation of paying dividends. They also tend to be a little cheaper to own.

And I say cheap because you have to keep in mind with stock prices always moving, the goalposts are always shifting. And one way to measure that goalpost is what they call the price-to-book ratio.

So this is something that investors are often talking about. The idea is to take the ratio of where the company is trading or the market price per share and dividing that by the amount of net assets that it has on its balance sheet or the book value per share. So the idea here is given the size of the company on paper, how high are investors valuing it?

So let's take an example, right? Tesla, OK, obviously a growth stock. Now sorry, my handwriting is terrible on this, but the P/E ratio for Tesla is 24. Now compare that to Ford which is, again, a storied company, history of dividends. This is a stock that has a P/E ratio of 1. So the difference between a growth stock and a value stock is quite obvious here.

Now lately growth stocks-- again, those sports cars-- have dramatically outperformed value. So what you're looking at here are two ETFs that break up the Russell 1000, which is a 1,000-list company of large- and mid-cap US stocks. And the purple line, the one up top here, is comprised of the growth stocks, the Russell 1000 Growth ETF, whereas the blue line here is the Russell 1000 Value ETF-- IWF, IWD.

And year to date, the value has really underperformed, right? It's actually down about 7% this year. Whereas if you look at growth stocks in the Russell 1000, it's popped by about 28% year to date in the middle of a deep, deep recession.

So this is going to tell you a little bit about the profile of the market right now, right? This is the components that make up the Russell 1000 Growth, and you can see the heavy weighting here. Almost half of it is in information tech. Think Facebook. Think Google. Think Zoom. There's also consumer discretionary, health care, communication, consumer staples.

Very different if you look at what's underlying the Value ETF, right? So first of all, the weighting is not as heavy for the top-held stocks, and it's a little different. You have financials, industrials, communication. You can see there is some overlap, so your health care, information tech is also in here, which means that it's not all tech stocks that are growth, right? It depends on the financial profile of these types of things.

But the overall story here that I want to illustrate is that obviously it's been the tech stocks that have been pulling the market up. And there are other factors too like low-interest-rate environments that have pushed people to kind of push for yield, get a little riskier, buy that fast car as opposed to the Toyota Camry.

But again, when it comes to buying the sports car or the reliable sedan you can pass down to your kids, it's really all about pricing. What do you think is worth it? And that, ultimately, is what investors should be thinking about when they evaluate growth versus value. Zack, Akiko.