Growth stocks in which people invest frequently, have the future potential and substance at the same time. With this “growth strategy”, investors achieve long-term price gains. In addition, a dividend payment cannot be ruled out in the future, even for growth companies. In this post you will find out which are the best growth stocks, when is the right time to start and under which circumstances an investment would make sense.
Getting rich with stocks – this is every investor’s dream. The prospect of rapid price gains is probably one of the reasons stocks are so popular. The riskier the investment, the supposedly higher the chances of winning. But is that really true? What does it mean to invest in growth stocks?
What are growth stocks?
Growth stocks are stocks that have above-average growth potential. In order to distinguish such growth stocks from value stocks, the following characteristics can be used:
- At least 20% increase in sales per year, over the past three years
- Specific competitive advantages
- Above average market valuation
Pros and Cons of Investing in Growth Stocks
The advantages and disadvantages of investing in growth stocks at a glance:
- + Profits stay with the company and increase future profits
- + Above-average return prospects
- + Chance of above-average dividend yield with early entry
- – High price / earnings ratio
- – Higher and more rapidly occurring losses are possible
- – Waiver of dividends at the beginning
- – Participation in capital increases to finance growth, may be necessary
- – Exaggerated profit expectations can drive the price up
Advantages of growth stocks
Compared to value stocks, growth stocks will rise faster in stock price. One of the reasons for this is that growth companies usually invest their profits exclusively in their own company. As a result, the share price often rises.
Compared to usual stocks, the rapid and sustained growth often enables above-average returns to be achieved. In addition, growth stocks offer the benefit of automatic reinvestment. Since shareholders are usually not paid a dividend, but rather the amount is reinvested directly in the company, investors do not have to take any further action with growth stocks. In addition, dividends that are above the tax exemption must be taxed. This tax liability does not apply to growth stocks as no dividends are paid.
Disadvantages of growth stocks
Compared to value stocks, growth stocks have a particularly high P / E ratio. This value usually disheartens many investors. In addition, companies with above-average growth, pay little or no dividends, as the profits are usually invested in their own company. Growth stocks with dividends are therefore rather a rarity.
In addition, the rapid development of the supposed growth industries, such as e-commerce, biotechnology and high technology, creates a greater risk. Because often growing companies can no longer meet their profit expectations for the coming years. If a supposed growth stock is in free fall, investors need to act particularly quickly to keep losses as low as possible.
Find the best growth stocks
Successful investing in growth stocks requires in-depth knowledge of the company and the market in which it operates. Investors often just jump on the bandwagon without researching the background. That can go well, but in the event of problems they then do not have the necessary basis to make decisions about a necessary sale. It is not uncommon for investors to be left with high losses with such supposed price rockets or to sell unnecessarily.
A special phenomenon in the growth stocks segment is that their successes are paramount. Success stories sell better than realistic assessments of opportunities and risks. Possible weaknesses are put in the background and often not adequately addressed by analysts. Especially the possibilities of balance sheet make the analysis of company figures difficult for non-experts.
Evaluation criteria for growth stocks
Many promising growth stocks fail to make early-stage profits or sacrifice them for research and sales expenses. Basically this is a good idea, but it makes a valuation using the most popular P / E ratio (price-earnings ratio) impossible.
This is often negative or very high for growth stocks and discourages inexperienced investors. Professional investors therefore look at the PEG ratio (Price Earnings to Growth). For this, the P / E ratio and the company growth expected for the next 3 to 5 years are compared. If the value is above 1, the P / E ratio is higher than expected growth and the stock is considered overvalued.
As long as no profit has been made, sales growth is often used as an indicator for assessing growth. But here, too, caution is advised. Some companies push customer growth and sales at the expense of margins and are therefore not competitive in the long term.
How to Find the Best Growth Stocks
Indications of good growth companies are provided by so-called “soft key figures”, which are not so easy to calculate and which require in-depth research or industry knowledge.
Basically, a growth company should be active in a growing market and offer products for a large target group that promise a large profit margin. In order to set themselves apart from current and future competitors, they must have specific competitive advantages. The so-called Unique Selling Point, better known under the abbreviation USP, describes why the products of this company are better than others.
Management also plays a major role in a successful growth company. In addition to the short-term, it should also pursue long-term growth goals and come up with a coherent concept of how it can achieve them. Efficient financial management with sufficient equity and liquidity are the be-all and end-all. This is not only important for corporate development, but also to avoid capital increases and the associated dilution of shareholder capital. Good problem management and the communication of failures are also indicators of integrity and capable management.
Where to look for growth companies
In every economic era, there are certain industries in which there are a particularly large number of growth companies. And always wherever innovative ideas develop or completely new branches of industry emerge. In the 1990s, it was telecommunications, media and high-tech companies that benefited from the development of the Internet and technological advances.
Today, Automobile industry is in the spotlight with advancing technology, safe emissions and futuristic demand. They offer innovation potential and extraordinary growth opportunities. Biotechnology, e-commerce, cloud and streaming services or internet security are also among today’s high-growth industries in which it is worthwhile to look out for companies with unique products and services.
Examples of growth industries in recent years
The rapid development of technology has caused a real boom in many areas. Some industries have particularly benefited from this, producing numerous growth stocks in recent years.
- E-commerce
- Streaming Services
- Cloud provider
- Telecommunication
- Automobile Industry
Our tip: The developments in the individual industries can be fast-moving. The rapid advances in technology in particular contribute to this. Rapidly growing companies with high growth can also quickly see a downward trend again. Strong growth is therefore not necessarily to be equated with rising share prices.
Investing in Growth Stocks – The Right Time
Many experts agree that it is hardly possible to time the market in order to generate performance. With stocks of above-average companies, you can sit out and achieve an excellent long-term return, even if you bought at the wrong time. Our experience also shows that it is worth holding on to carefully selected companies with high growth rates, even if the share price development can be below average for various reasons.
Nevertheless, one does not have to invest in growth stocks at any price, because exaggerated profit expectations often lead to unjustifiably high stock prices. The fear of not being part of a booming stock can drive prices even further. It is therefore advisable to keep additional liquidity available for acquisitions in addition to the entry position. Because buying opportunities can arise faster than you think, especially with growth stocks.
For example, with short-term problems. Because even successful companies sometimes suffer setbacks. If exaggerated profit expectations are disappointed, the share price quickly collapses. Bad news from the industry or general course corrections due to macroeconomic developments can also lead to favorable entry opportunities.
Conclusion
Growth stocks offer great potential – but they also involve great risk. Because it is often not easy for investors to distinguish between real growth and pure speculation. In addition, the forecast growth can often not be maintained. Unexpected decisions at management level can also cause the price of the growth stock to slide. If you want to focus on growth companies with growth investing, you should therefore find out about the advantages and disadvantages and not ignore the risks.
