Jasmine Birtles
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Everything You Need to Know About Growth Stocks (Your Ticket to £1 Million?)
Ruby Layram
18th Oct 2024
Growth stocks offer the promise of skyrocketing returns, but they also come with a bit of a risk. These stocks can be very alluring, especially for young, new investors who dream of house deposits, new cars and big holidays.
But, what exactly are growth stocks and are they a good investment?
In this article, we’ll walk through everything you need to know about growth stocks—from what they are, how they differ from value stocks, how to spot them, and whether they might be a good fit for your investment portfolio.
If you’re hoping to build serious wealth (and yes, maybe even hit that magical £1 million!), then growth stocks could be a big part of your strategy. But be careful! These stocks come with risk.
- What are growth stocks?
- Examples of growth stocks
- How to spot a growth stock
- Should you add growth stocks to your portfolio?
What Are Growth Stocks?
Growth stocks are stocks for companies that are expected to grow much faster than the overall market. These are the companies that tend to be in industries like tech, healthcare innovation, or green energy—basically, sectors that are evolving and expanding at a rapid pace.
What makes growth stocks so exciting is that the companies behind them are focused on reinvesting their profits back into the business to fuel even more growth. That could mean developing new products, expanding into new markets, or investing heavily in research and development.
While all this sounds great, it’s important to remember that growth stocks don’t usually pay dividends. They’re not for people looking for steady, predictable income. Instead, you’re relying on the value of the company to go up over time.
Growth Stock Definition
To give you a dictionary-worthy definition: Growth stocks refer to companies that exhibit above-average growth rates compared to other stocks in the market. In other words, they’re growing fast—whether that’s in terms of revenue, profits, or even market share.
Examples of Growth Stocks
Some of the most popular stocks could be considered to be growth stocks. In fact, I wouldn’t be surprised if you already had at least one of these in your portfolio!
- Amazon – Amazon wasn’t always part of the magnificent 7. The company used to be a modest bookseller. Early investors who saw the company’s potential probably made excellent returns!
- Tesla – Known for disrupting the auto industry, Tesla is what you might call a ‘textbook growth stock’, with its value soaring as the world moves toward electric vehicles.
- Zoom – Zoom had a tremendous growth spurt during the COVID-19 pandemic, as people turned to video conferencing for work and social connections. It’s a great example of how some growth stocks can take off due to trends (it’s worth keeping an eye on the news!).
These companies have all seen their stock prices rise dramatically over a short period. This is one of the traits that make growth stocks exciting and appealing to optimistic investors.
Growth Stocks vs Value Stocks
The opposite of a growth stock is a ‘value stock‘. You might have heard of value stocks if you’ve ever done a bit of digging into Warren Buffet’s investing strategy. A well-rounded portfolio might include a bit of both, to take advantage of both types of investment.
Here is an overview of the difference between the two types of stock.
Growth stocks are companies that investors believe will grow faster than the market. They are often more expensive based on metrics like the price-to-earnings (P/E) ratio because investors are willing to pay more now in anticipation of higher future earnings.
Value stocks, on the other hand, are companies that appear undervalued based on their fundamentals. Investors buy them because they think the market is underpricing them. This might happen because they’re in more stable, mature industries or because the market hasn’t yet caught onto their potential.
Investing in value stocks is a bit more risk-averse. These investments can be backed by solid stock research and analysis. However, there is no guarantee that an undervalued stock will rise. You can’t predict the market!
How to Spot a Growth Stock
When you’re picking stocks for your portfolio, it can be helpful to know which ones are growth stocks. This will give you an indication of the grow potential and risk profile of the investment.
Here are a few questions to ask to determine whether a stocks is a growth stock.
Does the Stock Have a High P/E Ratio?
Growth stocks typically have a high price-to-earnings (P/E) ratio. This means that the price of the stock is high (compared to it’s returns) now because earningsare expected to grow rapidly in the future.
However, a high P/E can also mean the stock is expensive, so it’s important to look at other factors too.
Is It a New Company?
Growth stocks often come from newer companies. These companies might not have a long track record, but they make up for it with the potential for high growth.
Think of companies like Tesla in its early days, when it was seen as disruptive but highly promising.
Is the Company Operating in a Fast-Growing Industry?
Fast-growing industries, such as technology, renewable energy, and biotech, tend to produce a lot of growth stocks. If the company you’re looking at is in an industry that’s expanding quickly, that’s a good sign that it could be a strong growth stock.
Does the Company Reinvest Its Profits?
Companies with a growth focus tend to reinvest their profits back into the business instead of paying dividends. This means they’re likely pouring money into new products, research, or expanding their market share. This is a sign that they’re planning for the future.
Does the Company Have a High ROE (Return on Equity)?
Return on equity is a measure of how efficiently a company is using its shareholders’ money to generate profits. Growth companies usually have a high ROE because they’re reinvesting profits into their business and getting a good return on that investment.
Benefits of Investing in Growth Stocks
There is a good reason that so many investors are interested in adding growth stocks to their portfolios. Here is an overview of the benefits that come with growth stocks.
- Potential for high returns – Growth stocks have the potential to increase in value much faster than other types of investments. If you pick the right stocks, the return on investment can be amazing!
- Capital appreciation – Since growth companies reinvest profits rather than pay dividends, investors benefit from the stock’s value increasing as the company grows. Over the long term, this can result in a substantial increase in the price of your shares.
- Diversification – Adding growth stocks to your portfolio can provide a good balance to more conservative investments, giving you exposure to faster-growing areas of the market.
Risks of Growth Stocks
Of course, no investment is without risks, and growth stocks are no exception to this rule. Here are some potential downsides to keep in mind:
- High volatility – Growth stocks can be more volatile than other types of investments. Since they’re valued based on future potential rather than current earnings, their prices can swing dramatically based on market sentiment.
- No dividends – Most growth stocks don’t pay dividends, so if you’re looking for regular income, these may not be for you.
- Higher risk – Because growth stocks are betting on future earnings, there’s a higher risk that the company might not grow as expected. If the company fails to meet its growth targets, the stock price can fall quickly.
Should You Add Growth Stocks to Your Portfolio?
Now, you’re probably wondering whether investing in growth stocks is a good idea for you in 2024. The answer depends on a few factors, which you should consider carefully.
Are you comfortable with a bit of risk?
Growth stocks come with the potential for high rewards but also higher risks. If you’re okay with some ups and downs in your portfolio and are comfortable with a bit of uncertainty, growth stocks could be a good fit.
Are you investing for the long-term?
Growth stocks usually need time to grow. You’re not likely to see massive returns overnight (although wouldn’t that be amazing?). If you’re investing for the long-term (at least 5 to 10 years) growth stocks can be a great way to build wealth over time.
Can you afford to lose the money you invest?
It’s always important to invest money that you’re willing to lose, especially when it comes to growth stocks. The companies behind these stocks can be volatile, and while the potential for gain is high, there’s also the chance of loss.
Growth stocks can be an exciting and potentially very rewarding part of an investment portfolio, particularly if you’re aiming to build long-term wealth.
By focusing on companies with strong growth potential, reinvesting profits, and operating in expanding industries, you could be setting yourself up for significant gains down the road.
But, growth stocks don’t come without their risks. It is important to spend a lot of time on research and analysis before you make any investment decisions.
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Disclaimer: MoneyMagpie is not a licensed financial advisor and therefore information found here including opinions, commentary, suggestions or strategies are for informational, entertainment or educational purposes only. This should not be considered as financial advice. Anyone thinking of investing should conduct their own due diligence. When investing your capital is at risk.
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