In this article, we will read about the growth stocks, features of growth stocks, risks of growth investing, and other different aspects of it. Growth investment can be good for wealth accumulation if done right.
Companies are like children, they grow up. The growth is fast at the initial stage like of a child. They grow physically and then in the later stage, the growth is much more mental and emotional.
Similarly, a company grows in number in the initial stage, and in the later stage, it grows in quality of its output, creates brand value and goodwill.
So, in the initial stage, the growth is fast and so is the increase in its value of shares. Growth investment is nothing but investing in stocks that are increasing in value rapidly than other shares in the market.
What are Growth Stocks?
Growth Stocks are those which have a high potential to grow in value. They are generally of the young companies which are in the growing stage.
This can be a lucrative investment option for investors. These stocks have huge potential for growth and accumulating wealth for the investors.
However, there are certain risks associated with them as well which we will discuss later in the article.
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Features of Growth Stocks
Growth stocks are for risk-takers. The investors who love risk and want a higher return, growth stocks are ideal for them. Here are certain attributes of the growth stocks –
- High P/E Ratio: The companies which have huge potential to grow in the future generally have a high P/E ratio. This indicates that the stocks of this company are in demand as it can provide wealth accumulation to the investor. The price of these stocks is also higher in the market which increases the P/E given the fact that earnings are less in the initial stage. However, high P/E is not always a good indicator for growth stocks. This is because the market can be influenced by external factors as well and the P/E can be high in such a scenario.
- PEG: This stands for the Price-earnings to growth ratio which evaluates the total increase in earnings over years. The previous ratio (P/E) does not indicate the performance of the company. To chalk out this limitation of the P/E ratio, PEG is put to use. This helps in understanding how the company is performing and its potential for the future. There are very few chances of having misleading results by using PEG.
- Solid foundation: Companies with a solid foundation – great fundamental values generally come out with growth stocks. The growth potential needs to be based on a solid foundation. To evaluate the same, you can use ROE or return on equity ratio. Generally, growth stocks have an ROE of 15% and above in a year.
Advantages of Growth Investing
There are different benefits of investing in growth stocks –
- High return: The first and foremost benefit of growth stocks to the investors is a high return. Since these companies are growing, there is huge growth potential. Growth if directed to profit, will eventually increase the share price. Higher return means fast wealth accumulation. Long-term capital gain is the main focus of growth investing. Here the tax rate is also generous which means you can retain most of your profits from the investment.
- A weapon against Inflation: Growth stocks investment can be used for hedging against inflation. The rate of growth in these stocks is generally higher than the inflation rate. So, the wealth you accumulate or the profit you make is higher than the inflation. Thus, the real income is positive and you gain even though there is inflation.
- Sustained growth: Growth stocks generally provide sustainable growth over years. Since these companies are new, they have a long way to go. If you can invest in the right growth stock, you can expect consistent yearly growth of your investment.
Risks Involved in Growth Investing
Growth stocks are high risk-high return investment instrument. Investors expect a high return from these stocks but they have to avail higher risk as well. These stocks are risky as
- The companies are new and do not have enough experience. This might lead to mismanagement and losses. This in turn will affect the stock price. They might have to wind up as well if they cannot sustain themselves.
- There are no dividends payments from these companies in most scenarios. As these companies are growing and expanding extensively, they use all the profit in expansion.
- There is high volatility noticed in these stocks. If you are investing in growth stocks, evaluate the market and the stocks before you invest.
- The growth of a new company might be a result of economic conditions. For example the dot com bubble. Then the technology companies had huge growth but then the bubble burst leading to blood bath on Dalal Street. So, before investing in growth stock, evaluate the company in and out and the performance, and its financials.
How to choose growth stocks?
Growth stocks seem lucrative but there are risks associated with them as mentioned above. So, how you can choose the growth stocks for a proper investment is the question, right?
Here are certain things to look for –
- Consistent and exceptional growth: For investing in growth stocks, you need to check if the company is growing over at least five to ten years. If the growth is consistent or not. The EPS of the company needs to grow over the years. The EPS depends on the size of the company and accordingly it needs to grow over the years.
- Growth in earnings: The earnings of the company need to grow directly. The actual earnings must surpass or at least touch the estimated earnings by the analysts. You need to find out which companies are growing at an above-average rate.
- Solid ROE: Return on equity is a key metric in understanding the potential of a company. You need to check the ROE of the last five years and evaluate whether it is increasing or not. At least a stable ROE is necessary for growth stocks.
- Great profit margins: Profit margins need to be exceptional especially in the initial stage. You need to check the sales and the revenue and the earnings together. This will help you understand how efficient the management is in using the revenue.
- Performance of stock: Finally, you have to observe how the stock is performing in the market. If the stock is in demand, the price will eventually increase. The high P/E can be used here for analyzing its demand. You need to check how fast the price of the stock is increasing and at what rate.
Growth Stock – Conclusion
Growth stocks are exceptional for long-term investment and wealth accumulation. They have huge potential to grow in value.
However, it is important to choose the right growth stocks for investment. Not all stocks increasing in price or having high potential are growth stocks.
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