Understanding Growth Stocks: Definition, Characteristics & Investing

Growth stocks are stocks that offer a substantially higher growth rate as opposed to the mean growth rate prevailing in the market. It means that a growth stock grows at a faster rate than the average stock in the market and consequently, generates earnings more rapidly.

Characteristics of Growth Stocks

1. High growth rate

As their name suggests, growth stocks tend to show a significantly higher growth rate than the average market growth rate. It implies that the stocks grow at a faster pace than the average stock in the market.

2. Low or zero dividends

Growth stocks usually pay either low dividends or zero dividends at all. It is because growth companies are growing at a very fast pace, and hence typically want to reinvest their retained earningsRetained EarningsThe Retained Earnings formula represents all accumulated net income netted by all dividends paid to shareholders. Retained Earnings are part back into the company to boost the revenue-generating capacity of the business.

3. Competitive advantage

Growth companies usually demonstrate a significantly higher growth rate because they tend to possess some kind of competitive advantageCompetitive AdvantageA competitive advantage is an attribute that enables a company to outperform its competitors. It allows a company to achieve superior margins over other companies in the same industry. The competitive advantage gives growth companies a unique selling proposition (USP), which helps them sell and grow better than other companies within the same industry.

4. Loyal consumer base

Since growth companies enjoy a competitive advantage over other companies within the industry, they tend to enjoy a loyal, growing consumer base. The USP that such companies enjoy over their competitors ensures a constantly growing consumer base, which contributes to their increasing growth rate.

5. Revenue

Since growth stocks pay either very low or zero dividends, investors don’t make much out of their investments in the short term. However, the long-term outlook is completely different. Investors are able to generate substantial revenues through capital gainsCapital Gains YieldCapital gains yield (CGY) is the price appreciation on an investment or a security expressed as a percentage. Because the calculation of Capital Gain Yield involves the market price of a security over time, it can be used to analyze the fluctuation in the market price of a security. See calculation and example, after seeing growth companies experience two-fold, three-fold, or multi-fold growth over the years.

6. Risk factor

Investments always come with some amount of risk. Such a fact is not also foreign to growth stocks. While growth stocks are a very attractive investment option and can generate substantial profits in the long term, the level of uncertainty surrounding them in the short term contributes to a high risk factor.

Such uncertainty arises from the fact that growth stocks usually pay low or no dividends. Hence, the investor only profits from the investment in the long term, provided the company performs well. In the rare case that the company fails to perform, the investor may incur losses. Hence, like every investment, there is a risk factor attached to growth stocks.

Illustrative Examples

1. Amazon.com Inc. (AMZN)

Amazon is considered one of the best-performing, successful growth stocks over the years, as one can tell from the giant online retailer’s immense and continuing success over the years.

2. Facebook (FB)

Facebook is another growth company that’s been extremely successful over several years. While once being the most popular growth stock, Facebook suffered its own set of setbacks in recent years relating to data privacy issues, violation of privacy rights, and other issues. Despite the numerous challenges, Facebook remains one of the most successful growth stocks, with an ever-increasing growth rate.

3. Apple Inc. (AAPL)

Apple is another one of the most sought-after growth stocks over the years. Apple’s been able to achieve a continuous, increasing growth rate at a very fast pace, primarily because of a very brand loyal consumer base. The company oversees a brand that consumers want to affiliate themselves to – not just a product, but the brand altogether. In addition, unique and high-quality products and constant innovation give Apple a competitive edge over its competitors.

4. Netflix (NFLX)

Netflix joins our list of profitable growth stocks. Just like the aforementioned growth companies, The online streaming giant started small but operated well in gaining a loyal, growing consumer base and providing streaming services. Since the company was the first one to offer such services, it enjoyed a competitive edge over other market participants, helped by an already established loyal consumer base. Hence, Netflix was able to grow as significantly as it did.

More Resources

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