What are value stocks and why should you care?

One of the many ways to categorize stocks is growth versus value. Growth stocks have a high value compared to the book value of their assets. This is because, typically, investors are assuming high growth rates for these stocks. A prime example would be Amazon, which is currently trading at about 13 times its book value (the value of its assets in the company's accounting records.)

The opposite of a growth stock is a value stock. Value stocks are considered "out of favor" for some reason. Value stocks often have more mature businesses, steady growth rates, relatively stable earnings, and are trading for a lower price to book value. An example of growth stock would be Johnson and Johnson, which is selling for a price to book ratio of around 6, about half that of Amazon.

The chart below shows that historically, value stocks have outperformed growth stocks in the US, and the outperformance in a given year has often been striking.

• Data covering nearly a century backs up the notion that value stocks—those with lower relative prices—have higher expected returns.

• Value premiums have often shown up quickly and in large magnitudes. For example, while the average annual value premium since 1927 has been 4.1%, in years when value outperformed growth, the average premium was over 14%.

• There is no evidence investors can reliably predict when value premiums will show up. Rather, a consistent focus on value stocks is essential to capturing these outsize value premiums when they do appear.

Logic and history support a commitment to value stocks so investors can be positioned to take part when those shares outperform in the future.

I'm happy to talk about your risk tolerance and the risk of your investments on a complimentary call. As a fee-only fiduciary advisor, I never receive commissions and therefore am unbiased on this topic.

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Disclaimer: Any indices referenced for comparison are unmanaged and cannot be invested into directly. Investments in securities involve the risk of loss. Nothing in this blog should be considered financial advice or recommendations. Your questions are unique to you and your own personal financial circumstances. You should consult with a financial professional before making a financial decision. See full blog disclaimer.