What is a Growth Stock in Investing?

“A growth stock is a share in a business that’s shown above-average earnings and has the potential to grow faster than the overall economy.”

- Merriledge

Growth stocks are stocks that have higher potentials of growing at an accelerated rate compared to the mean growth rate dominant in the market. Basically, a growth stock is a stock that grows at a faster rate compared to the average stock in the market. The implication of its fast growth is its ability to generate more earnings in a given time.

Growth Stocks Explained

Growth stocks are relatively more expensive than the average stock in the market, investors are likely to pay more for each share based on the company’s current earnings than they would pay for other stocks with slow growth rates. If the stock value eventually increases, investors can claim that value in the form of capital gains when they sell the stock. Growth stocks may seem very appealing to investors, however, they are thought to be risky, considering their ability to react faster to market changes.

Most tech and biotech companies fall under the category of growth stock considering the fact that technology is gradually becoming the focal point of society. For example, companies like Amazon.com Inc. (AMZN), Facebook (FB), Apple Inc. (APPL), and Netflix (NFLX) are some of the top growth companies today. Closely related to growth stocks is a sector called “emerging” growth companies. This includes firms that have good potentials to achieve high earnings growth over time but are yet to establish a growth history.

Growth stocks can be generally characterized by their high growth rate, capital gains, competitive advantage, low or zero dividends, risk factor, and loyal consumer base.

• High growth rate: stocks in this category are able to significantly grow at a fast pace beyond the average market growth rate.

• Capital gains: Growth stocks are able to generate substantial revenue for investors in the long term, through capital gains. Normally, investors may not necessarily make much out of their investments in the short term.

• Competitive advantage: Growth companies are mostly at advantage to other companies within the same industry considering the fact that they significantly demonstrate a higher growth rate. Growth companies have a unique selling proposition (USP) which helps them sell and grow better compared to other companies in their industry.

• Low or zero dividends: This contributes to the fact that growth investors are likely not going to make much returns in the short term. Growth companies reinvest their profits or dividends back into the company rather than distribute them amongst investors. The purpose of this is to boost its growth pace and its capacity to generate even more revenue per time.

• Risk factor: All investments usually come with risks and investing in growth stocks can be quite risky. Growth stocks may be attractive with the ability to generate significant revenue in the long term, however, it comes at a price. There is a high level of uncertainty involved in the short term. Since growth stocks do not pay investors dividends in the short term, the investor is left to wait for long term profits, provided that the company performs well. If otherwise is the case, the investor is left with little or no chances of making profit.

• Loyal consumer base: Growth companies are at an advantage of gaining wide acceptance and popularity in the market compared to other companies within the same industry. As a result of this, it has better potentials of building a large consumer base through its USP. Based on consumer behavior in economics, consumers are most likely going to be loyal to a company that the majority approves of.