Income, Value and Growth Stocks
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.
Most stocks can be classified into one of three categories: growth, income and value;
This is a stock that is growing at a faster rate than the overall markets, and they often devote most of their current revenue towards further expansion – so a low dividend payout ratio and all profits reinvested. Every sector of the market has growth companies, but they are more prevalent in some areas such as technology, alternative energy and biotechnology.
Growth stocks tend to be newer companies with innovative products that are expected to make a big impact in the market in the future i.e. disruptive firms. Growth companies can also be established companies that are very well-run entities with good business models that have capitalized on the demand for their products and have opportunities for further expansion.
An example of a growth company is:
Starbucks (Nasdaq:SBUX) – This coffee giant still has a great deal of room to grow. Its aggressive expansion plans include substantial additional penetration into international markets, with plans to double its presence overseas into China and Vietnam
A value stock is a stock that trades below the price the it should be trading at i.e. an undervalued company. This could be a large established mature company with a high dividend payout ratio, but the market undervalues it because e.g. of a recent scandal that the CEO was involved in. The market will soon forget this and the stock could be most likely to return back to its fair price, so a value investor would come in and spot this mis-valuation by the market and buy the stock when it is at a low. However, their prices do not always return to their previous higher levels as expected. The stock price may have dropped due to factors that have little to do with the company’s current operations.
An example of a good value stock in 2013 is:
McDonald’s – This stock was trading at around $90 per share in January 2013, and some analysts felt that the stock’s target price was $97 a share due to its projected 5% growth of corporate revenue and 9% growth of company earnings. By July 2013, the stock reached this target price.
Investors look to income stocks for dividend yields that typically exceed those of guaranteed instruments such as treasury securities or CDs.
There are two main types of income stocks. Utility stocks are common stocks that have historically remained fairly stable in price but usually pay competitive dividends. Preferred stocks are hybrid securities that behave more like bonds than stocks. They often have call or put features or other characteristics, but also pay competitive yields.
The Bottom Line – Stocks can provide a return on capital from future growth, current undervaluation or dividend income.