A stock is a type of security that reflects proportional ownership in the issuing company and is typically traded on stock markets. A company issues stock to raise capital for business operations.
A growth stock is any share of a company that is expected to increase at a rate substantially above the market average. In general, these stocks do not pay dividends. This is due to the fact that the issuers of growth stocks are typically corporations seeking to reinvest their earnings to accelerate growth in the short term. When investors purchase growth stocks, they expect to realize capital gains upon selling their shares in the future. Growth stocks typically have high P/E ratios and appear to be costly. Still, if the company maintains its rapid growth, which would increase the share price, such values may actually be reasonable.
Growth stocks typically have a few similar characteristics. For instance, growth companies typically have distinctive product lines. They may possess patents or have access to technologies that provide them with a competitive advantage in their industry. To maintain a competitive advantage, they reinvest profits in the development of even more innovative technologies and patents to assure long-term growth.
Numerous small-cap stocks are typically seen as growth stocks. However, some larger companies may also be seen as growth stocks.
How Do Growth Stocks Outperform The Market?
Any sector or industry may have growth stocks, which often trade at a high price-to-earnings (P/E) ratio. They may not have earnings at the time, but it is anticipated that they will in the future.
Growth stock investments can be a risky proposition. Since they do not normally pay dividends, the only potential for an investor to profit from their investment is when they finally sell their shares. Growth stocks typically have a few distinct characteristics. For instance, growth companies typically have distinctive product lines.
They may possess patents or have access to technologies that provide them a competitive advantage in their industry. In order to maintain a competitive advantage, they reinvest profits in the development of even more innovative technologies and patents to assure long-term growth.
Because of their innovation patterns, they frequently have a devoted customer base or a substantial market share in their field. For instance, a company that develops computer applications and is the first to offer a new service could become a growth stock by earning market share as the sole company offering the new service. If similar app businesses enter the market with their own versions of the service, the company that attracts and retains the most customers has a stronger chance of becoming a growth stock.
Features And Characteristics
Low or Zero Dividend
Growth stocks typically pay either minimal or no dividends. Because they are expanding quickly, growth companies often desire to reinvest their retained earnings back into the business to increase its potential for generating revenues.
Competitive Advantage
Growth companies typically have a much greater growth rate than other companies in the same market because they possess a competitive edge. The competitive edge provides growth companies with a unique selling proposition (USP) that enables them to sell more products and grow faster than competitors in their industry.
Risk
Investments always include some degree of risk. This fact is not foreign to growth stocks either. Although growth stocks are a very attractive investment option and can create considerable gains over the long run, their short-term volatility contributes to their high-risk profile.
This uncertainty stems from the fact that, typically, growth equities pay little or no dividends. Therefore, the investor will only profit from the investment if the company operates successfully over the long run. In the unlikely event that the company underperforms, investors may experience losses. As a result, growth stocks, like all other investments, are subject to market risk.
Long-Term Returns
Since growth stocks pay either very tiny dividends or none, short-term returns on investments are minimal. However, the picture for the long term is entirely different. Investors can create considerable profits through capital gains as a result of the twofold, threefold, or multifold growth of growth companies over the years. For example, (Amazon and Flipkart)
Exclusive Customer Base
Since growth companies have a competitive advantage over other firms in their market, they typically have a loyal and expanding customer base. The unique selling proposition that these companies possess over their rivals ensures a continually expanding consumer base, which contributes to their accelerating growth rate.
Investment Horizon
Since growth stocks do not pay dividends or pay small amounts, investors with short-term objectives cannot benefit from them. However, the situation is entirely different for investors with a long-term horizon. As a result of their exponential long-term expansion, growth enterprises can produce attractive revenues through increased capital gains.
Historical Examples of Growth Stocks In India
Please see below historical examples of certain growth stocks. However, please note that historical returns are not indicative of future returns.
In 1979, the Government of Gujarat established Gujarat State Petrochemicals Corporation Limited. The company’s revenue has increased by 63 percent every year for the past five years, reaching Rs 12,244 Cr in the year 2020.
In 1994, it was renamed Gujarat State Petroleum Corporation Limited in an effort to develop a firm footing in the whole hydrocarbon value chain. Over time, the GSPC Group has been the only oil & gas conglomerate in India to be promoted by a state government, and the Government of Gujarat has been successful in achieving its goals.
Average 5-year Sales Growth: 62.98 percent
Turnover: Rs 12,244 Cr
The GSPC Group, comprised of twelve enterprises and institutions, has established itself as one of the major E&P (Exploration and Production) companies with a commanding presence throughout the whole hydrocarbon value chain. Innovation and new technology are utilized by the group to continuously enhance its operations in both the upstream and downstream sectors.
It was founded in Jaipur in 1996 as Au Financier, then a non-deposit-taking Non-Banking Finance Company (NBFC), and it worked effectively to support economic growth, particularly for under-served and un-served low and middle-income individuals. In the past five years, the company’s revenue has increased by 43.5 percent every year, and its turnover is Rs. 4,841 Cr.
For more than two decades, the company has provided secured financing to consumers, primarily in the vehicle loan, business loan, and housing loan markets, while expanding its regional footprint organically.
Average five-year Sales Growth: 43.5 percent
Turnover: Rs 4,841 Crore
In 2015, when the RBI released the Small Finance Bank licensing standards, AU was the strongest of the ten selected companies out of 74 applicants to get this coveted license due to its solid footprint and track record.
Aditya Birla Capital Limited (ABCL) is the holding company for Aditya Birla Group’s financial services divisions. ABCL is a universal financial solutions organization that caters to the different demands of its consumers throughout their life stages.
Average 5-year Sales Growth: 44.03 percent
Turnover: Rs 18,488 Crore
In the past five years, the company’s revenue has increased by 44.03 percent every year, and its turnover is Rs 18,488 Cr. ABCL’s subsidiaries have a national reach with more than 850 branches, more than 2,000,000 agents/channel partners, and many bank partners, and are supported by over 22,000 employees.
Adani Transmission operates in the power transmission industry. With an enabling policy environment, major capacity expansions, and more prospects for private engagement through tariff-based competitive bidding, India’s power transmission sector is well positioned for growth.
Average 5-year Sales Growth: 145 percent
Turnover: Rs 11,416 Crore
The company’s annual revenue has increased by 144.55 percent during the past five years. The company’s three-year growth has made it one of the top growth stocks in India.
Suumaya Lifestyle Limited Company, founded in 2011 by Mr. Mahesh Gala, is a highly innovative company for exquisite fashion that offers the world’s greatest variety of Indo-Western Designer Kurtis. The company’s sales have increased by 41.5% year-on-year for the past five years, and its turnover is Rs 1,327 Crore.
With over 30 years of experience in the Indian ethnic products sector, the company has created and perfected techniques to provide bespoke patterns ranging from classic to contemporary, all of which exude elegance and beauty.
Average five-year Sales Growth: 41.5 percent
Revenue: Rs 1,327 Crore
The brand has been able to set the standard in the Indian ethnic wear market by providing an unrivalled assortment of patterns and fabrics coupled with unrivalled customer service, resulting in tens of thousands of monthly visits from around the globe.
In the past five years, the company’s revenue has increased by 61.6 percent annually, and the company’s turnover is Rs 18,488 Cr. In 2018, Apollo TriCoat (formerly known as Best Steel Logistics) joined the Sudesh Group of Companies, India’s top steel pipe, and tube maker. The SG group is a pioneer in the production of premium-quality steel tubes and pipes and has an annual production capacity of 2 million tonnes. Apollo TriCoat intends to boost the steel tubes and pipe manufacturing industry with its superior products, which are not confined to tubes and pipes alone.
Average sales growth during the past five years: 61.6%
Turnover: Rs 1,234 Crore
Apollo TriCoat has a manufacturing facility at Malur Industrial Area, Bengaluru, with a total capacity of 50,000 tonnes. Its headquarters are located in New Delhi, India.
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Why Should You Invest in Growth Stocks?
Investing in growing stocks gives significant returns. If you want to accumulate wealth over the next five years, you should invest in growth equities. Long-term returns are possible with growth stock investments. It is subject to long-term capital gains, which provide up to Rs. 1 lakh in tax benefits.
They are more prone to risk, yet offer a greater risk-to-reward ratio. Consequently, if the company does successfully, you will earn enormous earnings in the future. Investing in growth stocks will result in larger returns than investing in other equities. Investing in the growth stocks of various industries also provides a wonderful opportunity to diversify your portfolio through growth stocks.
You can also invest in a growth mutual fund if you are a first-time investor in growth stocks. This is referred to as a growth fund. They are a sort of mutual fund that invests in growth stocks and offers higher long-term returns.
Risks Associated with Growth Stocks
Even though some growth stocks make enormous returns for their investors, the unpleasant reality is that the majority of growth companies lose shareholder wealth over time.
A few years ago, J.P. Morgan published eye-opening research that gave a reality check. The study analysed the performance of all individual Russell 3000 Index stocks from 1980 to 2014. This index was chosen by J.P. Morgan because it represented approximately 98 percent of the investable U.S. equities market during the time period. Here is an outline of the important findings of the study:
- Forty percent of the index’s companies dropped more than seventy percent from their peaks and never recovered. Technology, telecommunications, energy, and healthcare, which are often viewed as “growth” industries, had significantly greater odds of failing.
- In their lifetime, around two-thirds of all individual equities underperformed the index.
- Approximately 7 percent of companies were “extreme winners,” or equities that outperformed the index by more than 450 percent.
As can be seen, the odds that a randomly selected growth stock would outperform the market were approximately one-third. And the odds that a particular stock will be an “extreme winner” are significantly lower. This data demonstrates why diversification is so crucial for growth-oriented investors. Investing in a basket of growth stocks as opposed to just one or two can significantly boost the odds of acquiring exceptional winners. Diversification serves as both a risk management technique and a method for improving long-term performance, as a single extreme winner can outweigh the losses of several losing investments.
Causes For Underperformance:
- High Evaluation: Investors that are willing to pay a high price for a growth stock do so because they believe the company is capable of sustaining rapid growth for many years to come. These high valuations represent high expectations for the business, which are often so big that it becomes impossible for the corporation to meet them. And when the company inevitably reports market-disappointing earnings, many investors sell all at once, sending the share price into a tailspin. This also increases the volatility of a stock, which can be unsettling.
- Poor Execution: Business strategies are always appealing on paper, but they do not always succeed in practice. If a growth stock company fails to successfully introduce a new product or service, the repercussions can be severe.
- Technological Disruption: Various growth stocks operate in industries that are rapidly evolving and upending the status quo. While this might result in astronomical expansion during prosperous times, the disruptor can sometimes find itself disrupted by new technology.
Conclusion
Growth investment is not for everyone, but when executed well, it may result in life-altering wealth. If you can devise a method based on thorough research that enables you to purchase prospective winners and hold on to them for the long term, you will be in an excellent position to build wealth for your family.
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