Investment word of the day: Growth stocks — what are they and how to identify them?

Investment word of the day: Maximising returns is one of the most important goals of any investor. When investing in the stock market, most investors look for shares of the companies that will earn them the most out of their money. Here's where the concept of growth stocks becomes important.

What are growth stocks?

Stocks expected to grow significantly compared to others are called growth stocks. Investors put money in such stocks with the anticipation of higher returns in future. However, there is no particular criteria to define growth stocks.

How are growth stocks different from other stocks?

There are several factors that can be used to differentiate growth stocks from other stocks.

• Anticipation of higher earnings in future.
• Growth in sales compared to competitors.
• A high price-to-earnings (P/E) ratio highlights the current price of a company’s share in relation to its earnings per share.
• High price earnings to growth ratio, which reflects the relation between the P/E ratio of the company and its future earnings.

How can investors identify growth stocks?

“Growth stocks reinvest their profits into expanding operations, developing new products, or entering new markets. This always results in high stock prices, which makes them good for investment for long-term investors who intend to accumulate wealth,” according to Siddharth Maurya, Founder & Managing Director, Vibhavangal Anukulakara Private Limited.

“The most critical aspect contributing to growth stocks is their potential to outperform the wider market, especially during economic expansion. These are companies in the technology, healthcare, and consumer goods sectors. For example, Tesla and Amazon, with time, showcased rapid expansion due to innovation, market demand and effective business strategies. Although they might have a higher price-to-earnings (PE) ratio, their potential returns justify the higher valuation,” Anukulakara added.

He further advised investors to prioritise companies with a record of consistent revenue and earnings growth, usually outperforming the sector. Other indicators are strong competitive advantages such as unique technology, patents, or actual brand loyalty, which suggest growth sustainability. Furthermore, analysing management efficiency, return on equity, and industry prospects helps to realise a company’s potential. A further indicator is a company’s market share relative to the industry’s overall growth.

However, it must be noted that growth stocks are highly risk-prone due to the anticipation of future growth and uncertainty; hence, investors must adopt the right strategy over the long term to get better returns.