What Are Growth Stocks?
A growth stock is a company that is expected to grow at a rate significantly above the average growth for the market. In general, growth stocks do not pay dividends; this is because they typically reinvest profits to generate increased growth in the company. When investors invest in growth stocks, they anticipate that they will earn money principally through share price gains when they eventually sell their shares in the future.
Growth stocks can appear expensive, trading at a high price to earnings (P/E) ratio, but such valuations could actually turn out to be bargains if the company grows rapidly, driving a rapid increase in the firms earnings. If this fails to materialise, and growth those expectations aren't realised, growth stocks can see dramatic declines in share price.
As with all investing, there is a trade-off between risk and return. Growth stocks provide a greater potential for future returns which is matched by higher risk that the future growth in company stock prices and earnings will not materialise.
Since they typically do not offer dividends, the only opportunity an investor has to earn money on their investment is by selling their shares, hopefully at a higher price than they originally paid. If the company does badly, investors take a loss on the stock when it's time to sell. It can also be difficult to decide when to exit the position in the stock as there can still be hope of future growth that may recuperate prior losses.
Growth stocks tend to share a few common characteristics; growth companies may have unique product lines or have access to technologies that put them ahead of their industry competitors. To stay ahead, they reinvest the profits of their activities to continue the development of newer technologies and revenue streams to ensure the continued growth in earnings.
Because of their commitment to innovation, they can often have a loyal customer base or hold a significant market share in their industry. A company that expands into a new market segment, being the first to provide a new product or service, may become a growth stock as they will be able to quickly grow their earnings due to the initial advantage they have over their competitors. The more competitors that enter the new area, the more uncertain that the stock will be able to maintain its market share and revenue growth, e.g. Tesla in the electric automotive industry.
You can find growth stocks trading on any exchange and in any sector—but you’ll usually find them in more innovative industries and as newer fastest-growing stocks on smaller exchanges like the AIM Market.
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