A share of stock is just a share of a company’s earnings. The question is, how much are you willing to pay for those earnings?

Stocks trade at some multiple to their earnings. For example, if GE is earning $1 per share, investors might pay $10 or even $20 per share to buy the stock. In the first case, the price-to-earnings ratio would be 10 and in the second 20. The higher the price-to-earnings ratio, the more enthusiasm investors have for the company’s profits. Stocks trading at high price-to-earnings ratios are considered “growth” stocks. A lot of hope and speculation is built into their price, so they are dangerous to hold–one mis-step by the company, and the stock price could drop by half or more in a hurry, as we’ve seen with Starbucks recently. A value stock, on the other hand, is already trading on the cheap. GE right now is trading at maybe 5 times earnings, which is almost insane. The stock pays a fat dividend, the company does not appear to be headed to bankruptcy, but the market expresses no enthusiasm for the company’s profits and is willing to offer just 5 times the earnings for the stock. A value investor might load up his basket with shares of GE right now, enjoying a high dividend yield and waiting for the profits and the stock price to rise slowly over time. If you recall the Morningstar equity style box, growth is considered more volatile than value. Small cap is also more volatile than large cap, so in terms of volatility, the lowest would be “large cap value,” while the highest volatility would be expected in the “small cap growth” fund.
What if a mutual fund manager won’t stick to either growth or value stocks? The industry just shoves him into the “blend” category and keeps moving. And let’s do the same, as there are so many more testable points you need to know for the Series 65 or 66.


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