Firms that are predicted to develop at a higher rate than the market are considered growth companies. As a result, their stock has the potential to outperform the market and are known as growth stocks. Investors in these companies believe that the rapid increase in earnings will make the stock more appealing in the future, resulting in a higher price. These stocks are frequently from startups in early-stage sectors.
What are the benefits of Growth Stocks?
Rate of growth is high: Growth stocks, as the name implies, increase at a considerably faster rate than the market as a whole. It signifies that the stocks are growing at a higher rate than the market average.
Dividends are low or nonexistent: Growth stocks are known for paying either low or no dividends. Because growth firms expand at such a rapid rate, they often desire to reinvest their interest income back into the business to increase its revenue-generating ability.
Advantage in the marketplace: Because they have a competitive edge over other firms in the same sector, growth companies often have a much greater growth rate. Growth firms with a competitive edge have a unique selling proposition (USP) that helps them sell and expand faster than their peers in the same sector.
How to Identify Growth Stocks?
Growth stocks can be identified using the following two ratios.
Price- Earning Ratio: Companies with strong development potential have a high price to earnings (P/E) ratio, which indicates that people see a company's complete potential and anticipate it to grow at exponential rates in the future.
P/E ratio = Market value per share/Earnings per share
Price Earning- Growth Ratio: Investors use the price-earnings-to-growth ratio to identify growth shares in India from conventional equity shares due to the P/E ratio's limitations. The key advantage of the PEG ratio over the P/E ratio is that it accounts for the yearly increase in a company's total profits per share.
PEG ratio = Market value of unit shares/ Earnings per share growth rate
Why are growth stocks termed as a risky investment?
Growth stocks firms want to make money by establishing a big market edge through competitive marketing practices. Such corporations frequently forego dividend payouts to reinvest in expansion, which is a significant drawback for investors.
The prolonged economic situation in a country can also affect the performance of growth stocks. In the event of a financial bubble, every firm operating in that industry is likely to outperform its potential. Because it is dependent on an economic anomaly, such growth can be deceiving.
If a company loses money, investors will lose money in the long term since no dividend payments are made during the lock-in period.
Growth stocks are typically issued by firms in the early stages of development and are hence particularly vulnerable. Because of their volatility, they are significantly impacted by market swings. Even while this characteristic allows enterprises to generate big profits during market upswings, even minor price turbulence can result in massive losses.
Due to the growing nature of the issuing firm, investing in growth stocks in India can be a dangerous financial endeavour. As a result, buying stocks of a growth company is great for risk-averse investors seeking large returns on their whole investment.