This is the headline investor category. Growth stocks drive media interest and market enthusiasm. Buying shares in a company whose stock price rises over time, or rockets higher in no time, can be one of the more exciting – and profitable – investments you’ll make.
Stocks come in different styles: out of favor companies with solid, but under-appreciated financials are known as value stocks. But high-flying firms with rising revenues and promising profits are the growth stocks that grab the spotlight.
How to identify a growth stock
While many times growth stocks erupt, seemingly out of nowhere, from innovative, new companies — they can also be found in a mature industry. Some companies are simply better managed and outpace the growth of the market in general and their competition in particular. Other companies discover new markets for their products or services, such as overseas trade, that fuels substantial new profits.
Growth stocks can also come from existing companies that develop new products or transition to a new technology – or ride the wave of a sudden social change. A mature company with stagnant growth like the IBM of the 1970s, can see its fortunes rise, such as in the mid-1990s when the advent of the personal computer market spurred new sales, only to fade again when more innovative competition came on the scene. That is the hard knocks arena of growth stocks.
It can be difficult to identify a growth stock, not necessarily from a financial analysis standpoint, but because of the fact that many times they are well hidden. Many are obscure, sometimes small companies that are just on the verge of a break-out. And they can be flying below the radar in a highly technical or specialized industry.
Growth stocks can also be fully valued by the time they come to your attention. Finding the “hidden nugget” that hasn’t yet been fully discovered by the market can be an exciting part of your research process. Accelerating sales, up-trending earnings growth, and excellent profit margins are some of the qualities to look for.
The very nature of a growth stocks means that your investment may be at a greater risk. Big upside potential can also mean big downside potential. Be prepared to monitor your investment carefully for hidden weaknesses that can slow momentum.
The Alibaba IPO has fallen into the same trap as Facebook (Nasdaq: FB) and Twitter (Nasdaq: TWTR).
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