Growth Stock

What Is a Growth Stock?

A growth stock is any share in a company that is anticipated to develop at a rate essentially above the average growth for the market. These stocks generally don't pay dividends. This is because the issuers of growth stocks are normally companies that need to reinvest any earnings they accrue to accelerate growth in the short term. When investors invest in growth stocks, they anticipate that they will earn money through capital gains when they eventually sell their shares from here on out.

Understanding Growth Stocks

Growth stocks might appear in any sector or industry and typically trade at a high price-to-earnings (P/E) ratio. They might not have earnings right now but rather are expected to from now on.

Investment in growth stocks can be risky. Because they typically don't offer dividends, the main opportunity an investor needs to earn money on their investment is when they eventually sell their shares. On the off chance that the company does not get along admirably, investors take a loss on the stock when now is the right time to sell.

Growth stocks tend to share a few common traits. For example, growth companies tend to have unique product lines. They might hold patents or have access to technologies that put them ahead of others in their industry. To remain ahead of competitors, they reinvest profits to develop even newer technologies and patents as a method for ensuring longer-term growth.

Because of their patterns of innovation, they often have an unwavering customer base or a lot of market share in their industry. For example, a company that develops computer applications and is quick to provide a new service might become a growth stock by approach to gaining market share for being the main company providing a new service. In the event that other app companies enter the market with their own versions of the service, the company that manages to draw in and hold the largest number of users has a greater potential for becoming a growth stock.

Numerous small-cap stocks are considered growth stocks. However, some larger companies may likewise be growth companies

You can find growth stocks trading on any exchange and in any industrial sector — but you'll normally find them in the fastest-developing industries and on more innovative exchanges like the Nasdaq.

Growth Stocks versus Value Stocks

Growth stocks differ from value stocks. Investors expect growth stocks to earn substantial capital gains as a result of strong growth in the underlying company. This expectation can result in these stocks appearing overvalued because of their generally high price-to-earnings (P/E) ratios.

In actuality, value stocks are often underrated or ignored by the market, but they may eventually gain value. Investors additionally attempt to profit from the dividends they typically pay. Value stocks tend to trade at a low price-to-earnings (P/E) ratio.

Some investors might try to include both growth and value stocks in their portfolios for diversification. Others might prefer to specialize by zeroing in more on value or growth.

Some value stocks are underpriced simply due to poor earnings reports or negative media attention. However, one characteristic that they often have is strong dividend-payout histories. A value stock with a strong dividend history can provide reliable income to an investor. Many value stocks are older companies that can be counted on to remain in business, even on the off chance that they aren't particularly innovative or poised to develop.

Example of a Growth Stock

Amazon Inc. (AMZN) has long been considered a growth stock. In 2021, it is one of the largest companies in the world and has been for quite a while. As of Sept. 24, 2021, Amazon positions fourth among U.S. stocks in terms of its market capitalization.

Amazon's stock has historically traded at a high price-to-earnings (P/E) ratio. Between June 2020 and September 2021, the stock's P/E has ranged from around 58 to 106. Despite the company's size, earnings per share (EPS) growth estimates for 2022 is over 67.

When a company is expected to develop, investors remain able to invest (even at a high P/E ratio). This is because several years down the road the current stock price might look cheap in hindsight. The risk is that growth doesn't continue true to form. Investors have paid a high price expecting one thing, and not getting it. In such cases, a growth stock's price can fall emphatically.

Highlights

• Growth stocks typically don't pay dividends.
• Growth stocks often look expensive, trading at a high P/E ratio, but such valuations could really be cheap assuming the company continues to develop rapidly which will drive the share price up.
• Growth stocks are often put conversely, with value stocks.
• Since investors are paying a high price for a growth stock, based on expectation, in the event that those expectations aren't realized growth stocks can see sensational declines.
• Growth stocks are those companies expected to develop sales and earnings at a faster rate than the market average.

FAQ

How Do You Know If a Stock Is Growth or Value?

Instead of shifting focus over to future growth potential, value stocks are those that are remembered to trade below what they are really worth and will consequently theoretically provide a superior return as their stock prices find fundamentals. Unlike growth stocks, which typically don't pay dividends, value stocks often have higher than average dividend yields. Value stocks likewise tend to have strong fundamentals with comparably low price-to-book (P/B) ratios and low P/E values — the opposite of growth stocks.

Are Growth Stocks Risky?

Similarly as with all investing, there is a fundamental trade-off between risk and return. Growth stocks provide a greater potential for future return, and they are consequently equally matched by greater risk than other types of investments like value stocks or corporate bonds. The principal risk is that the realized or expected growth doesn't continue into the future. Investors have paid a high price expecting one thing, and not getting it. In such cases, a growth stock's price can fall emphatically.

What Is Considered to Be a Growth Stock?

When it comes to stocks, "growth" means that the company has substantial room for capital appreciation. These tend to be newer and smaller-cap companies, or potentially those in growth sectors like technology or biotech. Growth stocks might have low or even negative earnings, often making the high P/E stocks.

What Is an Example of a Growth Stock?

As a hypothetical example, a growth stock would be a biotech startup that has begun work on a promising new cancer treatment. Currently, the product is just in the Phase I stage of clinical trials, and there is uncertainty whether the FDA will approve the medication candidate to continue on to Phase II and III trials. In the event that the medication passes and is ultimately approved for use, it could mean huge profits and capital gains. In the event that, however, the medication either doesn't function according to plan or causes severe side effects, that R&D spending might have been all to no end.