Stock ETFs: The Difference between Growth Stock and Value Stock?
Many different criteria are used to determine whether a stock or basket of stocks (such as an ETF) qualifies as growth or value. But perhaps the most important measure is the ratio of price to earnings: the P/E ratio, sometimes referred to as the multiple.
The P/E ratio is the price of a stock divided by its earnings per share. For example, suppose McDummy Corporation stock is currently selling for $40 a share. And suppose that the company earned $2 last year for every share of stock outstanding. McDummy’s P/E ratio would be 20. (The S&P 500 currently has a P/E of about 15, but that ratio changes frequently.)
The higher the P/E, the more investors have been willing to pay for the company’s earnings. Or to put it in terms of growth and value:
The higher the P/E, the more growthy the company: Either the company is growing fast, or investors have high hopes (realistic or foolish) for future growth.
The lower the P/E, the more valuey the company. The business world doesn’t see this company as a mover and shaker.
Each ETF carries a P/E reflecting the collective P/E of its holdings and giving you an indication of just how growthy or valuey that ETF is. A growth ETF is filled with companies that look like they are taking over the planet. A value ETF is filled with companies that seem to be meandering along but whose stock can be purchased for what looks like a bargain price.