Growth investors are inspired by those who got in early on the stocks that would dominate the 21st century — Google, Facebook, Amazon and the rest. Unlike slow and steady value stocks and income-generating dividend stocks, growth stocks have the potential for upward trajectories that deliver three, four, five and even six-figure percentage gains.
But they also come with greater risks and special considerations. Here’s what you need to know about investing in growth stocks.
What Is Considered a Growth Stock?
Growth stocks are companies that fatten their revenues, profits and share prices much faster than the market as a whole. Growth stocks tend to be small, emerging, disruptive companies that threaten old and entrenched industry players.
Sometimes, they create a brand new product, service or idea, like Uber or Airbnb. In other cases, they take an existing idea and create new ways to scale it. Starbucks, for example, was hardly the country’s first coffee shop, but the company’s game-changing branding, marketing and product line made Starbucks a fixture in cities and towns across the country.
What Is a Growth Stock Example?
In the 21st century, the best examples of growth stocks have come out of the tech industry, with companies like Amazon and Facebook emerging as fledgling startups in a crowded field before roaring to the top of the S&P 500.
Growth stocks tend to be more expensive than other stocks because of their potential for outsized gains. Value stocks, on the other hand, are covered for being underpriced. Another hallmark of growth stocks is that they don’t pay dividends, or pay only nominal dividends. Instead of making periodic payments to their shareholders, growth companies reinvest every available dollar back into the company to grow it as aggressively as possible. That could mean investments in new technology, physical expansion, hiring, acquiring other businesses or accelerating production.
The tradeoff is heightened risk — that strategy makes growth stocks much more susceptible to steep losses during market downturns.
What Is the Best Growth Stock?
A lot of growth stocks have made a lot of people rich, but if you had to pick one best growth stock in the modern era, no one could blame you for guessing Apple, Google, Amazon or Netflix. But sometimes, under-the-radar stocks quietly turn their shareholders into millionaires while the big headline-grabbing companies gobble up all the attention.
In this case, it’s hard to argue that Monster Beverage (MNST) hasn’t been the best growth stock of the last quarter-century. Since it launched its IPO 27 years ago in 1995, Monster has generated total returns of more than 260,000%, making it the best-performing stock on the S&P 500 in the last three decades.
The company has delivered its shareholders annual average returns of 34.6%. A $10,000 investment in Monster at the very beginning would be worth more than $26 million today.
The trick, however, was to get in on the action in the mid-to-late ’90s before the secret was out. The thing about growth stocks is that a company can only grow so big. After a mad dash to the top, all growth stocks eventually level off.
What Are the 10 Best Stocks To Buy Right Now?
Only a qualified professional can give investment advice, but the following is a list of some of the best growth stocks of 2022, as well as their return on equity, which is a measure of how efficiently a company generates profits. You calculate ROE by dividing net income by shareholder equity.
|Company Name and Ticker Symbol||Return on Equity|
|T-Mobile US Inc. (TMUS)||2.5%|
|Vertex Pharmaceuticals Inc. (VRTX)||30.24%|
|MercadoLibre, Inc. (MELI)||28.57%|
|Alphabet Inc. (GOOG, GOOGL)||29.22%|
|Meta Platforms Inc. (FB)||25.48%|
The Potential for Outsized Gains Comes With Greater Risk
While growth stocks offer the chance at big gains, the tradeoff for a greater reward is always greater risk. As previously stated, growth companies reinvest most of their cash in the pursuit of massive revenues, profit growth and price appreciation.
This is a risky strategy that makes growth stocks susceptible to volatility, market downturns and internal problems.
When the market is up, growth stocks tend to outperform, but when the tides reverse and the market turns bear, growth investors often shoulder a disproportionate amount of pain. The tech-heavy growth stocks on the NASDAQ significantly outperformed during the previous decade’s bull market, but they also incurred much greater losses during the downturn of 2022.
Amazon might just be the market’s most famous growth stock, delivering an incredible return of roughly 1,500% during the 2010s — investors gained 65% between 2020-2021 alone. But that’s after it reached maturity. According to Forbes, the company shed a full 90% of its value during the dotcom bust, and it took nearly a decade for Amazon to recover.
Growth stocks also commonly forgo profits in the pursuit of rapid gains and expansion. Founded in 1996, Amazon didn’t record its first profitable year until 2003.
How To Find the Next Big Stock
A stock’s success is not always dependent on how big or influential a company is. It also has a lot to do with the current trends. Companies that capitalize on these trends generate more wealth and value for shareholders.
The COVID-19 pandemic was a case study in how societal changes can crack the door enough for the right growth stocks to bust out:
With lockdown restrictions in place, people predominantly shopped online. As expected, that raised the stock prices for companies like Shopify and Amazon. Meanwhile, international retailers like Alibaba also benefited.
As more companies started operating online, the need for digital advertising grew. Thus, companies like Alphabet and Facebook profited from this trend.
Since the whole world was under quarantine, the need for at-home entertainment grew. Therefore, streaming services like Netflix, Amazon Prime and HBO Max saw a rise in revenue generation.
The pandemic also shifted in-office work to remote or hybrid models. That increased the need for video calling and collaboration services like Zoom and Skype. Similarly, online schooling benefitted Google Classroom immensely as they saw a massive increase in the number of users.
Go For Growth — But Do It Carefully
When you include growth stocks in your portfolio, consider the heightened risk they present and mitigate that risk by including safer bets like dividend stocks and value stocks. According to Forbes, you should use P/E ratio analysis to seek out growth stocks that are already turning a profit. They tend to offer more stability than those that aren’t yet making any money. Also, avoid companies with a lot of debt on their balance sheets and stick with growth stocks with debt-to-equity ratios under 30%.
Scott Jeffries contributed to the reporting for this article.
Data is accurate as of Aug. 8, 2022, and subject to change.