Understanding Growth Stocks
Author: James Clark
Everything You Need to Know About Growth Stocks
The stock market is just like any other market. You have several types of stocks to choose from at different prices. Each of these stocks has its purpose, benefits, and drawbacks for investors. As the name suggests, these stocks belong to companies expected to grow in terms of revenue or profits faster than other stock types.
Of course, there’s no guarantee of growth stocks making you money since they’re extremely volatile. Nonetheless, they drive media interest and market enthusiasm so it’s important for any trader to at least understand how to identify and evaluate them.
If you’re a new stock trader finding your feet, here’s everything you need to know about growth stocks.
What are Growth Stocks?
Growth stocks are one of the several types of stocks in the market. What makes them unique is that they belong to companies expected to grow faster than others in terms of profit and revenue. As a result, growth stocks offer much higher returns than other stock types in the market, such as defensive or income stocks, etc.
How to Identify and Evaluate Growth Stocks
Like all stock types, growth stocks share some quantitative characteristics that investors can use to identify and evaluate them. These include:
1. High Growth Rate and Profit Margins
Growth stocks generally have a much higher growth rate than the market average. Companies whose stocks are identified as growth stocks are the ones that are growing faster than the average companies in the market. As a result, these companies have significantly higher profit margins over time.
2. High Returns on Equity
Return on equity is a measure of financial performance that tells you how efficiently a company uses its capital to make profits. Growth stocks have higher ROE compared to other companies in the same industry.
3. High-Risk Factor
All stock investments carry a certain amount of risk. Growth stocks are popular for generating substantial profits in the long term. However, they carry much greater risk in the short term because growth stocks hardly pay any dividends. So, stock traders have to wait a long time to make money. There’s always a chance that a company can fail to perform in the future, leading to losses.
4. Manageable Debt
Growth stocks generally belong to companies with low or manageable liabilities meaning they don’t carry huge amounts of debt or their debt levels are similar to that of their competitors.
Benefits of Investing in Growth Stocks
You might be wondering why any investor should buy growth stocks considering their high-risk factor. Here are two reasons why:
1. Successful Companies
Growth stocks belong to companies that are either already successful with continual growth or those showing high levels of potential success in the future. These companies include Apple and Amazon, both giants that continue to grow at a rapid pace leading to faster wealth accumulation for investors.
2. Great Potential for Success
The global business leaders you see around you every day were all aspiring startups once. So, there are thousands of diamonds (growth stocks) in the rough (stock market). For example, Netflix transformed from a rental store to the world’s leading streaming service.
Growth stocks bring about significantly higher returns than other stocks in the market but at greater risk. If you have a high-risk tolerance level, you should consider them. Even if you don’t, you can invest in these stocks as part of your diversification strategy to reduce your overall risk while expanding your stock portfolio simultaneously.
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