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Stocks and shares (pt 3)

This is an article about stocks & shares and how they relate to investing in general, not Orbis Access in particular.

Stocks and shares

Crusts look similar, but fillings vary

Value, growth & income stocks

Investors often put stocks & shares into different categories that share similar characteristics. Three of the most common are: value, growth and income.

Value and growth stocks are bought mostly on the expectation of future growth in share price. This is known as capital growth. Income stocks, by contrast, are bought primarily in the expectation of healthy dividends.

But a given stock isn’t necessarily confined to a single category. Also, it may shift categories over time.

Value stocks

Value stocks refer to companies that are cheap, relative to others, in relation to their earnings or book value (ie: total assets minus liabilities).

In theory they could be a bargain for the taking. The assumption is that at some point the market will come to its senses and recognise their real, intrinsic value. The share price then rises accordingly.

But of course the theory may not match the reality. The pessimism causing the stock to be valued low in the first place could be justified. The company may continue to struggle, with a share price languishing or dropping further.

Growth stocks

Growth stocks, by contrast, are bought on the assumption that the company will grow more rapidly than average stock and thus become more valuable relative to other stocks in future.

Typically, a growth stock is a relatively young company in a new (or fast growing) business sector. Rather than paying dividends to shareholders, the company may instead choose to pump cash back into the business to fuel further profitable expansion. The theory is that this leads to rapid growth in profits and in the share price.

The issue here is that other people may be thinking the same. This means the current stock price could already be factoring in a lot of future growth. And if that future growth fails to materialise, it means you paid too much for the stock.

Income stocks

These are considered attractive because of their relatively high dividend yields. Income stocks have proven track records of delivering stable profits that get converted into healthy dividends at regular intervals, year-in, year-out.

Such companies often operate in a mature industry, where it often makes sense to hand over profits to shareholders rather than investing the money to fuel growth.

Some (but not all) blue chip stocks are in this category. Blue Chips are well established, large corporations – often household names – with a long history of being listed on a stock exchange.

The danger with income stocks is that the company is unable to sustain dividend yields in future, or that other assets start generating more attractive income (eg: higher bank interest rates).

Related links

  • The value premium in a nutshell

    Loading up on the value premium is the financial equivalent of exploiting the sick and the weak.

    Monevator

  • Growth Investing

    Growth investing is about putting your money into companies you think will make greater profits in the future.

    Monevator

  • Different types of shares

    The return from shares comes in two forms; dividends and capital growth.

    Which?