Stories by Chinenye Anuforo and Chinwendu Obienyi
Investors who buy stocks typically do so for one of two reasons: they believe that the price will rise and allow them to sell the stock at a profit, or they intend to collect the dividends paid on the stock as investment income. Of course, some stocks can satisfy both objectives at least to some extent, but most stocks can be classified into one of three categories: growth, income and value.
Those who understand the characteristics of each type of stock can use this knowledge to grow their portfolios more efficiently.
Growth stocks
As the name implies, growth companies by definition are those that have substantial potential for growth in the foreseeable future. Growth companies may currently be growing at a faster rate than the overall markets, and they often devote most of their current revenue toward further expansion. Every sector of the market has growth companies, but they are more prevalent in some areas such as technology, alternative energy and biotechnology.
Most growth stocks tend to be newer companies with innovative products that are expected to make a big impact in the market in the future, but there are exceptions. Some growth companies are simply very well-run entities with good business models that have capitalized on the demand for their products. Growth stocks can provide substantial returns on capital, but many of them are smaller, less-stable companies that may also experience severe price declines.
An example of growth stock is Dangote Flour Mills. Ever since Dangote Group took it back from Tiger Branded, they have embarked on a massive turnaround that has seen the company report back to back profits for the first time in years. Investors have rewarded the company with higher valuation multiples.. More so, the stock is still trading at very low valuation multiples, perhaps as investors wait to see if it can generate enough growth to clear out its accumulated losses of about N6 billion.
Growth stocks generally have high Price-to-earnings (P/E) ratios and high Price-to-book ratios, and are sometimes seen as expensive and overvalued.
Value stocks
Undervalued companies can often provide long-term profits for those who do their homework. A value stock trades at a price below where it appears it should be based on its financial status and technical trading indicators. It may have high dividend payout ratios or low financial ratios such as price-to-book or price-to-earnings ratios. The stock price may also have dropped due to public perception regarding factors that have little to do with the company’s current operations. For example, the stock price of a well-run, financially sound company may drop substantially for a short time period if the company CEO becomes embroiled in a serious personal scandal. Smart investors know that this is a good time to buy the stock, as the public will soon forget about the incident and the price will most likely revert to its previous level.
Of course, the definition of what exactly is a good value for a given stock is somewhat subjective and varies according to the investor’s philosophy and point of view. Value stocks are typically considered to carry less risk than growth stocks because they are usually found with larger, more-established companies. However, their prices do not always return to their previous higher levels as expected. For example, Access Bank, United Capital Plc among others. Sometimes, Value Stocks may have prices that are below the stocks historic levels or may be associated with new companies that aren’t recognized by investors. They may also have been affected by a problem that raises some concerns about their long-term prospects – such as recently poor operating results and negative outlook.