One element that the Australian share market offers in abundance is growth stocks. These have had a profound history of generating market-beating returns for investors, as they make strong gains and have a lot more upside potential to go. With the several high-profile growth stocks that the Australian Securities Exchange (ASX) possesses, investors often rack their brains to decide which ones to buy.
But what are growth stocks? Let’s find out-
Growth Stocks and Characteristics
Growth stocks are shares of a company that is projected to expand at a rate substantially higher than the market average. Ideally, the revenues and earnings of these companies increase at a faster rate than the average company within the same industry and it bears a competitive advantage as well.
Characteristics of a growth stock
- These stocks showcase consistent topline and bottomline growth for long time durations
- The management team garners considerable attention from the investors
- The business calls for consistent growth capital in the form of higher capex, marketing budgets, R&D expenditure etc
- These stocks generally do not pay dividends
- Growth stocks typically are from those sectors that are from new age sectors such as of technology, biotech and at times when the overall economy does well the consumer discretionary companies also throw up growth stocks
- Growth companies tend to have unique product lines
- They reinvest profits to develop even newer technologies and patents
- They often have a very loyal customer base and a significant amount of market share in their industry
- As investors expect growth stocks to earn substantial capital gains, they tend to be overvalued
What Makes Investors Fascinated by Growth Stocks?
If one had to summarise why investors are attracted to investing in growth stocks, they would say- capital appreciation. Growth investors (as they are called), invest in companies with above-average growth.
Growth companies typically stand out as they have a durable moat that help the companies to sustain their competitive advantage and thus higher return metrics, such as consistent high ROE, higher growth rates, higher margins etc.
Growth investors are avid risk takers inclined towards nascent companies in position to quickly expand.
Behavioural Finance will Reap Benefits!
We are now taking the topic to the most important component of stock making decision- the human (here, investor) brain and his/her instincts. This is important to talk about, because a stock selection as risky yet beneficial as a growth stock undergoes a lot of learning, psychological instinct and market analysis before it is given the green flag from the investor’s end and added in his/her investing portfolio.
It is a common belief of the share market that an investor’s mindset truly defines his investing choice and consequently plays a vital role in delivering results. With psychology playing a key role in investing and a majority of market experts believing that investing decisions are directly linked to emotions, the concept of behavioural finance is gaining massive traction. Fund managers have noticeably been using behavioural finance concepts to select stocks and construct portfolios.
But what is behavioural finance and why is it so important? Let’s find out-
A sub-field of behavioural economics, behavioural finance suggests that psychological biases and influences have a substantial affect over the financial decisions of market participants.
Psychological behaviours are often thought to influence market outcomes and returns,for example, herd mentality is a huge influencer wherein people tend to follow a trending stock for its probable returns even without paying much heed to their requirements and affordability. They follow the herd because they are psychologically sure of its success witnessing the inclination of other investors, and a sense of security that stems from knowing others are also investing in the same asset.
The interdisciplinary field of behavioural finance focusses on examining the ways in which investors make financial decisions. Identification of the shortcuts, and other mental quirks that impact decisions are analysed to both understand and improve financial behaviour.
The past many years have had researchers from the field of psychology study different biases that clearly explain the ways in which investors make choices and tap elements that propel them to diverge from their rational economic outcome.
Want to Invest in Growth Stocks- Put on your Psychologists Hat!
There have been periods in history wherein growth investing has trumped value investing. This has been quite rampant of late, with more companies that have managed to come up with innovative business models to disrupt the old ways of doing things.
Mental fortitude is a necessity for growth investing. Moreover, the emotional trip of a growth investor lures him into investing in a growth company that has been doing well, in terms of their business which is then reflected in the share price. It becomes easy for investors to deduce that into the future resulting in them wanting to be part of the growth stock bandwagon.
As understood, buying the growth stock is the easy part, with safety in numbers- financials as well as the number of investors tapping the opportunity. But then comes the risky part, a stomach-churning ride wherein unexpected market events impact the decision made based on confidence and gut. For example, Amazon’s state in the dotcom stock bubble burst where it failed to provide comfort to investors up until a few more years as it started making profits much later and its stock tumbled month after month, with few experts believing that at one point in time, it had lost more than 90% of its value (even though long-term investors got rich eventually!)
Talking about the psychologist state of investors, it is interestingly noted that a fixed mindset was more commonly found in people who have an inherent ability or intelligence. However, a growth mindset builds only with hard work and dedication. Both these traits aid in making decisions to tap lucrative growth stocks.
We firmly believe that a growth investor needs to put in a bit of work, make vigilant choices and even then, success is not guaranteed to come automatically. There will be setbacks, and the psychology coupled with good analysis, market behaviour will decide the return and results for the investor.
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