When investing, your capital is at risk and you may get back less than invested. Past performance doesn’t guarantee future results.
Growth Stocks: Definition, Meaning, Examples, Pros and Cons
To grow your portfolio, you can’t ignore growth stocks.
This comprehensive guide gives a clear definition of growth stocks with real-world examples, providing you with insight into how to make them work for your investments.
This comprehensive guide gives a clear definition of growth stocks with real-world examples, providing you with insight into how to make them work for your investments.
Quote
"Growth stocks are as varied in their characteristics as a surgeon's instruments or a carpenter's tools and, similarly, successful results are dependent on knowledge and experience in their proper use."
Big ideas
- Growth stocks are a way to take advantage of the power of technological pioneers and industry trailblazers, offering the potential for high returns alongside higher risk.
- Balancing the pros and cons of growth stocks involves navigating these high rewards vs higher risks and what’s known as the investor's dilemma.
- If you can be patient, wealth accumulation through growth stocks involves identifying what are likely to be the sustainable winners and avoiding flash-in-the-pan overnight successes that are tomorrow’s duds.
What are growth stocks?
Definition
Growth stocks are a category of equities that exhibit a growth rate significantly above the market's average. These stocks outpace the typical market growth, both in terms of underlying earnings and share price performance compared to the average market stock.
The main distinction from other types of stocks is that growth stock companies strategically channel their earnings back into the business rather than paying out dividends. The basic idea is that this money can be put to better use to fuel higher growth and thus result in higher payouts for investors later via gains in the value of the shares.
The four broad ways that investors tend to define a stock are:
The four broad ways that investors tend to define a stock are:
- Growth
- Value
- Dividend/Yield
- Defensive
Investors are attracted to growth stocks by the prospect of above-average capital appreciation. This potential surge in value is rooted in the market's collective expectation of sustained strong performance and expansion from these companies. Often found in innovative and emerging sectors, growth stocks mirror the pulse of evolving industries and pioneering trends.
Their valuations mirror the market's confidence in their ability to harness future growth opportunities.
However, the alluring prospect of high returns comes hand in hand with elevated volatility and risks, demanding careful consideration in investment strategies.
Their valuations mirror the market's confidence in their ability to harness future growth opportunities.
However, the alluring prospect of high returns comes hand in hand with elevated volatility and risks, demanding careful consideration in investment strategies.
What are the features and characteristics of growth stocks?
Growth stocks, celebrated for their potential returns, showcase distinctive features integral to their popularity.
Although there are many features of a growth stock, we’ve prioritised the key characteristics that distinguish them from the other types of stocks just mentioned above.
Although there are many features of a growth stock, we’ve prioritised the key characteristics that distinguish them from the other types of stocks just mentioned above.
- Innovation: Pioneering technological advancements and market trends.
- Always reinvesting: Prioritise profits for strategic purposes like R&D, product expansion, and market penetration.
- Chance to scale-up: Business models designed for significant expansion to capture larger market shares as industries evolve.
- Top-line focus: Emphasising top-line growth over immediate profitability, i.e. sacrificing short-term gains for the chance at substantial future returns.
- Always seem ‘overvalued’: P/E and P/S ratios are justified by higher anticipated future earnings growth.
- Lots of ups and downs: higher volatility, influenced by sudden shifts in market sentiment and dynamic industries subject to lots of change.
Growth stocks examples
Amazon (AMZN) has transformed from an online bookstore into a global e-commerce powerhouse.
Key elements of its growth story include a commitment to innovation, relentless expansion into new markets, scalability and dominance in diverse sectors, a focus on top-line growth over immediate profitability, and a valuation evolution justified by consistent performance.
Here we spotlight five more growth stocks that have historically aligned with the same criteria mentioned in the last section.
Tesla (TSLA) is a pioneer in electric vehicles, Tesla exemplifies innovation, relentless expansion into renewable energy and solar technology and a valuation reflective of its potential future dominance in the automotive and energy sectors.
Square (SQ) is a tech-savvy financial services and mobile payment company that showcases innovation in the fintech space, relentless expansion through services like Cash App, and a focus on top-line growth, positioning it as a growth stock with considerable potential.
Zoom Video Communications (ZM) had a rapid rise amid the digital communication boom reflecting innovation in virtual collaboration technology, scalable solutions, and a valuation reflective of its sustained growth as an essential communication platform.
Shopify (SHOP) is a favourite among online store owners embodying scalability and supporting businesses of all sizes. Its constant innovation in online retail solutions, relentless global expansion, and focus on revenue growth contribute to its growth stock status.
NVIDIA Corporation (NVDA) is now one of a handful of companies valued at over a billion dollars. Known for its graphics processing units (GPUs), NVIDIA exemplifies innovation in artificial intelligence and gaming technology.
Key elements of its growth story include a commitment to innovation, relentless expansion into new markets, scalability and dominance in diverse sectors, a focus on top-line growth over immediate profitability, and a valuation evolution justified by consistent performance.
Here we spotlight five more growth stocks that have historically aligned with the same criteria mentioned in the last section.
Tesla (TSLA) is a pioneer in electric vehicles, Tesla exemplifies innovation, relentless expansion into renewable energy and solar technology and a valuation reflective of its potential future dominance in the automotive and energy sectors.
Square (SQ) is a tech-savvy financial services and mobile payment company that showcases innovation in the fintech space, relentless expansion through services like Cash App, and a focus on top-line growth, positioning it as a growth stock with considerable potential.
Zoom Video Communications (ZM) had a rapid rise amid the digital communication boom reflecting innovation in virtual collaboration technology, scalable solutions, and a valuation reflective of its sustained growth as an essential communication platform.
Shopify (SHOP) is a favourite among online store owners embodying scalability and supporting businesses of all sizes. Its constant innovation in online retail solutions, relentless global expansion, and focus on revenue growth contribute to its growth stock status.
NVIDIA Corporation (NVDA) is now one of a handful of companies valued at over a billion dollars. Known for its graphics processing units (GPUs), NVIDIA exemplifies innovation in artificial intelligence and gaming technology.
Advantages of growth stocks
1. The potential returns
Growth stocks offer the allure of high returns, with investments in companies on a robust growth trajectory potentially yielding substantial profits over time.
Example: Consider the meteoric rise of Tesla (TSLA), exemplifying the high return potential of growth stocks.
Example: Consider the meteoric rise of Tesla (TSLA), exemplifying the high return potential of growth stocks.
2. Compounding makes potential returns more compelling
The compounding factor can lead to exponential increases in revenue and earnings, fostering sustained stock appreciation.
Example: Amazon (AMZN) provides a compelling case for compounded growth with expansion in cloud computing (AWS), Grocery stores and more.
Example: Amazon (AMZN) provides a compelling case for compounded growth with expansion in cloud computing (AWS), Grocery stores and more.
3. Add some diversification to an income portfolio
Their performance, often uncorrelated with traditional value stocks, can provide a hedge against market fluctuations, contributing to a well-balanced investment strategy.
Disadvantages of growth stocks
1. The risk potential always follows the potential returns
These kinds of stocks are more susceptible to market fluctuations and economic downturns, exposing investors to increased risk and potential losses during turbulent periods.
Example: The volatility of growth stocks is evident in the experience of Square (SQ). While Square's innovative financial services and mobile payment solutions have contributed to its growth, the stock has also faced heightened volatility, exposing investors to increased risk
Example: The volatility of growth stocks is evident in the experience of Square (SQ). While Square's innovative financial services and mobile payment solutions have contributed to its growth, the stock has also faced heightened volatility, exposing investors to increased risk
2. High valuations make some investors nervous
When investors get spooked, it's often the stocks with elevated valuations that get sold first. Investors must scrutinise whether a stock's current price justifies its growth potential.
Example: The valuation concerns associated with growth stocks are exemplified by the experiences of Beyond Meat (BYND). While Beyond Meat surged initially, valuation concerns led to market corrections
Example: The valuation concerns associated with growth stocks are exemplified by the experiences of Beyond Meat (BYND). While Beyond Meat surged initially, valuation concerns led to market corrections
3. Foregone dividend income adds opportunity cost
While fostering future growth, this strategy means investors might miss out on regular income from dividend-paying stocks, affecting those seeking a consistent cash flow.
Example: Growth stocks like Netflix (NFLX), prioritising reinvestment for expansion, often forego dividend payments.
Example: Growth stocks like Netflix (NFLX), prioritising reinvestment for expansion, often forego dividend payments.
Growth stocks vs value stocks, key differences
Understanding the differences between growth stocks and value stocks is essential for crafting a balanced portfolio. Here are key differentiators between these two investment philosophies:
Investment Focus:
Growth Stocks | Value Stocks |
Prioritises companies with high future expansion potential, often trading at higher valuations with a focus on capital appreciation rather than immediate dividends. | Selects undervalued companies based on current market valuations relative to fundamentals, aiming for a future correction in stock prices. |
Company Characteristics:
Growth Stocks | Value Stocks |
Thrive in dynamic industries, emphasising innovation and scalability, reinvesting profits for high growth potential. | Often in mature industries, characterised by stability, consistent earnings, and potential dividend distribution. |
Valuation Metrics:
Growth Stocks | Value Stocks |
Higher valuation metrics (P/E, P/S) reflect optimism about future earnings growth. | Lower valuation metrics signal the market values these companies less relative to current earnings or sales |
Risk and Volatility:
Growth Stocks | Value Stocks |
High growth potential comes with higher risk and volatility, susceptible to market sentiment changes and economic fluctuations. | Perceived as less risky due to lower valuations, but may lack growth potential and face challenges if market recognition is delayed. |
Investor Behaviour:
Growth Stocks | Value Stocks |
Investors prioritise future capital appreciation, with a longer-term horizon and a tolerance for market volatility. | Investors seek current income through dividends, adopting a value-oriented strategy focused on stocks perceived to be below intrinsic value. |
Growth stocks vs dividend stocks
Some sectors of the stock market tend to be filled with dividend-payers, while others are dominated by growth stocks. The key is owning stocks and ETFs covering a range of sectors and with a mix of growth vs dividends that you’re comfortable with.
Income Generation:
Growth Stocks | Value Stocks |
Primarily focus on capital appreciation, reinvesting profits into the business for future expansion, with little emphasis on distributing dividends to shareholders. | Prioritise providing regular income to investors through consistent dividend payments, making them attractive to those seeking a steady cash flow. |
Company Characteristics:
Growth Stocks | Value Stocks |
Typically found in dynamic and innovative industries, with a focus on scalability and reinvesting profits for sustained high growth. | Often represent mature, stable companies with a history of consistent earnings, making them more likely to distribute profits to shareholders in the form of dividends. |
Valuation Metrics:
Growth Stocks | Value Stocks |
Higher valuation metrics due to market optimism about future earnings growth, with less emphasis on current income. | May have more conservative valuation metrics, reflecting the focus on distributing profits to shareholders. |
Risk and Volatility:
Growth Stocks | Value Stocks |
Higher risk and volatility due to the pursuit of high growth potential and susceptibility to market sentiment changes. | Generally lower risk, as the emphasis on consistent income provides a buffer against market fluctuations, appealing to more risk-averse investors. |
Investor Behaviour:
Growth Stocks | Value Stocks |
Investors prioritise future capital appreciation, often tolerating higher volatility and a longer investment horizon. | Investors seek regular income, appreciating the stability and reliability of dividends, making them suitable for those with a preference for income-focused strategies. |
Investment strategies for growth stocks
When incorporating growth stocks into your investment strategy, a nuanced approach can amplify the benefits and mitigate risks. Here are key investment strategies for optimising your growth stock portfolio:
Long-term investing in growth stocks
Embrace a long-term perspective when investing in growth stocks. The inherent volatility might test your resolve, but history has shown that patient investors often reap the rewards as these companies realise their growth potential over time.
Periodically reassess your growth stock holdings, ensuring they align with your long-term goals. Be prepared to adjust your portfolio based on changes in company performance, industry trends, or your own financial objectives.
You can make use of the dollar-cost averaging (DCA) strategy by consistently investing a fixed amount in growth stocks at regular intervals, regardless of market conditions. This disciplined approach reduces the impact of short-term market volatility on your overall investment.
DCA allows you to buy more shares when prices are lower and fewer shares when prices are higher. Over time, this can result in a lower average cost per share, enhancing the overall return potential of your growth stock investments.
Periodically reassess your growth stock holdings, ensuring they align with your long-term goals. Be prepared to adjust your portfolio based on changes in company performance, industry trends, or your own financial objectives.
You can make use of the dollar-cost averaging (DCA) strategy by consistently investing a fixed amount in growth stocks at regular intervals, regardless of market conditions. This disciplined approach reduces the impact of short-term market volatility on your overall investment.
DCA allows you to buy more shares when prices are lower and fewer shares when prices are higher. Over time, this can result in a lower average cost per share, enhancing the overall return potential of your growth stock investments.
Themes for growth stock investors in 2024 and beyond
The following table gives a snapshot of some of the biggest innovations taking shape this year and some example stocks prominent in the area, but not necessarily the stocks that will grow the most moving forwards.
Theme | Company | Stock Ticker |
Artificial Intelligence (AI) | NVIDIA | |
| Alphabet | |
Electric Vehicles (EV) | NIO, Inc. | |
| Ford | |
Gene Editing and Biotechnology | CRISPR Therapeutics | |
| Illumina | |
Renewable Energy and Sustainability | First Solar | |
| Enphase Energy | |
| Vestas Wind Systems | |
5G Technology and Connectivity | Qualcomm | |
| Ericsson | |
Space Exploration | Maxar Technologies | |
Cybersecurity | Palo Alto Networks | |
| CrowdStrike Holdings | |
E-commerce and Digital Payments | Amazon | |
| Block, Inc. (Square) | |
Healthcare Technology | Teladoc Health | |
Quantum Computing | IBM |
Not financial advice. Do your own research.
Recap
Growth stocks are shares in fast-growing companies like Amazon, Tesla, and Square. The clearest contrast is between growth stocks and value or dividend stocks. Growth stock investors focus on their potential for high returns, innovation, and scalability, but also have to understand and appreciate the extra risks from volatility and lack of dividends.
FAQ
Q: Are growth stocks high risk?
Yes because potential for significant returns comes with increased volatility, making them susceptible to market fluctuations and economic downturns. Investors in growth stocks should have a long-term perspective and tolerance for short-term price swings.
Q: What is considered a growth stock?
Any share in a company that people think can grow faster than your average company. The firms behind these kinds of stock almost always reinvest profits into the business to help innovation and operate in dynamic industries. Investors buy these stocks to benefit from possible capital appreciation rather than receiving dividends.
Q: What makes a growth stock?
The main attribute is a company's potential for high future expansion but usually also means innovation in dynamic industries, scalability, and a focus on reinvesting profits into the business. High valuation metrics, such as P/E and P/S ratios also tend to go along with growth stocks.
