What are growth stocks (explained for beginners)
Growth stocks refer to any stake in a company that is expected to grow at a rate above the average growth rate for the market. These stocks do not pay a dividend since their objective is to invest any dividends earned in order to accelerate the short-term growth of the companies. So when investors invest in growth stocks, they expect to make money in the future when they sell them back.
What are growth stocks?
Growth stocks may appear in any sector or industry and usually trade at a high price-to-earnings ratio. As mentioned earlier, growth stocks may not have any dividends right now, but investors are expected to earn dividends in the future.
Investing in growth stocks can be very risky, as they do not offer any dividends and the only chance for an investor to make money from his investment is when he finally sells the stock. If the company is not doing well, investors will lose out when it comes time to sell.
Growth stocks have some common features. Most growth companies tend to have unique product lines for example, or they may have patents or access to technologies that put them ahead of the curve. In order to stay ahead of the competition, they reinvest profits to develop the latest technologies and patents as a way to ensure long-term growth.
Because of their innovation patterns, they often have a loyal customer base or a large market share in their industry. A company developing computer applications that was the first to introduce a new service may become a growth stock with the goal of gaining market share by being the only company offering a new service. If other app companies enter the market with their own versions, the company that manages to attract and retain the most users has the highest probability of becoming a growing stock.
What are growth stocks and value stocks?
Growth stocks are a little different from value stocks. Investors expect growth stocks to earn significant capital gains as a result of the strong growth in the underlying company. This expectation can lead to an overvaluation of these stocks due to their generally high price-to-earnings (P/E) ratios.
Conversely, value stocks are often ignored and undervalued by the market even though they may eventually gain value. Value stocks tend to trade at a low price-to-earnings (P/E) ratio.
Some investors may try to include growth and value stocks in their portfolios for diversification, but others may prefer to specialize by focusing more on value or growth.
Some value stocks are undervalued due to poor earnings reports or negative media attention. However, this does not preclude that it has a strong dividend history, and a value stock with a track record of dividend payments can provide reliable income for the investor.
Always seen as a growth stock, Amazon (AMZN) was one of the largest companies in the world in 2021 and then ranked fourth among US stocks by market capitalization as of September 24, 2021.
Historically, Amazon stock has traded on a high price-to-earnings (P/E) basis. The price-to-earnings ratio per share has ranged from about 58 to 106.3 between June 2020 and September 2021. Estimates of earnings per share (EPS) growth for 2022 are over 67.4.
When a company is expected to grow, investors remain willing to invest even when the P/E ratio is high. However, the danger here remains in the possibility of a growth defect, which will lead investors to huge losses.
Frequently Asked Questions
What stocks are considered growth stocks? When it comes to stocks, “growth” means that the company has plenty of room to raise capital. These companies tend to be newer and smaller, or are among those in growth sectors such as technology or biotech.
Are growth stocks risky? As with all investments, there is always a close relationship between risk and return. Growth stocks offer greater potential for future return, and therefore come with an equally greater risk than other types of investments such as value stocks and bonds.
What is an example of a growth stock? A growth stock may be a biotechnology startup that has started working on a promising new cancer treatment. Right now, the product is only in Phase 1 clinical trials, and there is uncertainty about whether the Food and Drug Administration will approve the drug candidate to continue into Phase 2 and Phase 3 trials. If the drug is eventually approved, it could mean huge profits for investors. But if the drug doesn’t work as planned or causes severe side effects, loss is inevitable.
How do you know if a stock is growth or value? Growth stocks are expected to outperform the overall market over time due to their future potential, while value stocks trade undervalued and therefore theoretically provide a better return.
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