- Growth stocks are publicly listed growth-oriented companies, which are expected to perform better than the industry they are in and also their peer.
- Growth investors usually invest in such stocks with the hopes of benefitting from potentially explosive returns
- Some factors to help an investor identify good growth stocks include sectoral growth rate, management team, competitive edge and more
Growth stocks are stocks of companies that are expected to outperform their peers or industry with regards to stock performance and earnings.
Such type of stocks does not usually offer dividend pay-outs to their shareholders, however due to their high growth potential they have the potential to offer hefty returns.
What are growth stocks?
Since such growth-oriented companies grow at a very fast pace and tend to reinvest their profits for expansion or other such purposes, they are not for investors who buy such stock with the intention of earning dividend income from them.
However, growth stocks may also eventually evolve into a dividend paying company in the future, depending upon the company’s growth phase and management team’s goals.
Growth oriented companies vs mature companies
Growth stocks are usually young and fast growing companies, they also tend to be a riskier investment compared to more mature and stable companies. However, since larger and stable companies are considered a safer investment, they also offer lower levels of returns in comparison to growth stocks.
Growth oriented companies’ share prices also have the tendency to rise rapidly but can also move in the opposite direction due to higher volatility.
Alternatively, larger and more stable companies tend to not have as drastic share price movements as their growth counterparts.
Also Read: What are the best stocks under £1?
Factors to look for in growth stocks
Some factors an investor should consider to identify growth stocks are:
- Management team: Growth investors should look at a company’s management team as growth oriented companies that require strong leadership to innovate in their niche.
- Sector growth rate: A good growth stock should operate in a high growth industry or in an industry which is poised to grow at a rapid rate.
- Competitive edge: It is also important to identify stocks that have a significant portion of the market share as such stocks should be able to sustain their competitive advantage. The competitive edge that helps a company boost its stock prices can include unique products or patented technology, or better service quality. They can also have low-cost products as cheaper raw materials, a more efficient distribution network, and other factors that can positively reflect on the stocks prices.
- Earnings per share: Tracking a company’s earnings per share (EPS) can offer an insight into how the company is earning growth. EPS is also directly correlated with a company’s share prices; thus, rising EPS indicates the stock prices have appreciated as well.
- Rising profit margins: Good growth stocks have profit margins that increase over a period of time.
- Return on equity: A company having a high return on equity indicates the company uses its capital in a more efficient manner; thus, investors should factor this ratio into account prior to selecting a growth stock.
- Debt to equity ratio: Having a manageable level of debt is another factor to keep an eye on, as a company can show high returns on equity by assuming high debt levels.
- Strong sales growth: company which has a history of reporting strong sales growth and high earnings are attractive investment opportunities for growth investors.
- Overvalued stocks: Investors should avoid overvalued stocks as they may not accurately reflect the underlying fundamentals of a company’s real performance or financial health. Some financial ratios that can help understand this are price to sales ratio and price to earnings ratios to identify whether a stock is accurately priced.
Overall growth investing is a risky investment with the potential to provide investors with high returns. Knowing how to pick the right growth stock is essential for this type of investing.
While the above is some of the key factors an investor must consider prior to investing, it involves a great deal of research applying strong fundamental analysis, identifying macro trends and more are essential to pick a growth stock.