High-quality technology companies today are an example of growth stocks, which are also commonly spread out across a wide range of biotech and consumer industries. Here, Academy presents what beginning investors need to know about them, which have to potential to offer long-term gains, but can also be riskier than other stock investments.
What are growth stocks?
Companies that report above-average performance and strong potential to grow are sometimes said to be growth stocks, which are anticipated to grow at a much faster rate than other shares that are currently in the market.
Growth companies favor reinvesting earnings into accelerated expansion, which in turn may result in considerable capital gains on the short term. As such, these assets often do not pay out dividends, but are attractive because of their potential to be eventually sold for a much greater profit.
Read also: A simple guide to start investing in stocks
For additional perspective, growth stocks are most commonly compared to value stocks, which are usually valued lower than competitors AND regularly pay out dividends. Investors purchase these valuable stocks of companies going through expansion while prices are low, hoping that dividends grow just as the overall value of the stocks also gradually increase.
If you are just starting to diversify your portfolio, keep in mind that it could be good to have a healthy mix of both growth and value stocks.
Why invest in growth stocks?
We can’t accurately determine or predict how long a company can sustain present growth, but here are some reasons that growth stocks can be turn out to be highly advantageous to investors:
Growth stocks are tied to companies that are expected to continue experiencing high growth in the future, and it’s this chance to rapidly accumulate wealth that investors seek to capitalize on.
Some of the most sought-after blue-chip stocks were once high-potential growth stocks, themselves. When evaluating growth stocks to invest in, consider companies that are in a position to, one day, transition into a solid company.
While it can never be a guarantee, one of the advantages of growth stocks is that their sustained increase might allow them to withstand negative or downward trends that could affect the general market or industry.
What are the risks with growth stocks?
Any investment in the stock market inherently carries risk due to volatility and competition. The value of growth stocks is particularly dependent on their perceived potential for capital gains.
Growth stocks might generally be more expensive due to all the attention that they receive, but the actual value of these shares to individual investors is dependent on the company’s performance at the time they might decide to sell them.
They are likely to increase in value much faster than other kinds of shares, and investors can profit considerably from selling a stock of a well-managed company with attractive products and a focus on innovation. However, without the security of also receiving regular dividends, investors bear the direct responsibility of selling their stocks for a profit.
Since you would actually only realize a profit (or loss) once you sell any type of stock, careful timing also plays a part in financially benefiting from growth stocks. If sold too early, investors run the risk of missing out on additional profits. On the other hand, selling them too late may force investors to sell their stock at a significant loss.
Growth stocks can be very profitable stock market investments, but hold on!
Here are a few things to consider before you start building a stock market investment strategy:
- Are you personally in a financially-stable position with a steady income and enough savings to be able to take on the additional risk of actually entering the stock market?
- In terms of investment horizons, are you looking for quick gains or have immediate cash needs, or are you willing to leave your money invested for the longer term?
- To plan out the size and diversity of your ideal portfolio, how much time and effort are you willing to put into researching companies and maintaining a portfolio?
Evaluating growth stocks
Once you are confident with your own financial position and risk tolerance, here are some easily-accessible metrics and factors to consider when trying to identify and evaluate growth stocks:
This metric is a good indicator of a company’s size, and some advisors recommend screening out companies with a market cap of less than $300 million.
Sales and profitability
Companies that aren’t able to show consistent profits or are burning through capital are riskier than those with positive P/E ratios and growing revenues.
Although even expert analysts can never accurately predict a stock’s future performance, positive projections can tell you how much confidence the market has in a company.
Industries such as technology and services are known for focusing on innovation and growth, but it’s also best to stick with sectors you are familiar with or understand.
While some industries naturally rely on debt more than others, it is generally better for potential growth companies to maintain a debt-to-equity ratio below 20%.
The bottom line
Successful investment advisor and portfolio manager, Patrick McKeough, tells us that quality growth stocks, when chosen wisely, can be valuable components in diversified portfolios. Although they may be quite volatile, and carry relatively higher risk than their alternatives, they have been observed to shine as long-term investments.
Growth stocks grow at a much higher rate than those of other companies in the market, and can take many forms, coming from everything between well-established companies to rising industries. Once these investment gems are found, though, they have the potential to continue increasing in value for years, or even decades, into the future.