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What Are Growth Stocks?

There are two general classifications for a stock as it relates to increases in stock price and dividend payments. Depending on personal financial goals a investor will seek either to purchase a growth stock or income stock or some combination of the two.

Growth stocks are characterized by a number of overriding principles. The primary indication of a growth stock is rapidly increasing revenues. A company can be considered to be a growth stock if its revenue is increasing rapidly regardless of net income. In fact, a company can have negative net income, losing money, every quarter and still be considered a growth stock as in the case of Amazon. For the first few years Amazon continually lost money even though its revenue was increasing tremendously this is because all income was reinvested to facilitate rapid expansion.

Since all revenue is reinvested in the company growth stocks often pay no dividends. Growth stocks tend to have significant returns on equity, also known as ROE, of the least 15% or more. The hope is that as the company is expanding and revenue is increasing rapidly that this will lead to a dominant market share which will generate significant profits in the future.

Growth stocks are considered a high risk investment because investors and financial analysts tend to set very high per quarter revenue goals and companies that fail to meet these goals tend to get punished in the stock price. A growth stock which may have hit the quarterly earnings per share but failed to meet revenue expectations can see a significant depreciation in stock price. The expectation is that even though net income was on target revenue may be slowing which means the stock price should not be valued as highly as it may have been.

When that happens, and it always happens, growth stocks hopefully shift and become income stocks. At this point, a companies market capitalization is normally in the large cap category and revenues have slowed. The expectation is then that the company will start paying a quarterly dividend. This is most often associated with high tech companies such as Microsoft who grew rapidly for two decades into a dominant market position. Then growth slows but revenue is still very high which normally results in a dividend payment.

Growth stocks are most appropriate for young and middle aged investors as they tend to have the highest returns but are also very risky. When investors become older and are closer to retirement it is recommended to shift from growth to income earning assets to generate monthly or quarterly income and help preserve principle.

If you are interested in purchasing growth stocks be sure to do your research at one of the many online brokerage houses which provide financial information. Growth stocks tend to have rapidly accelerating sales growth, increasing year over year earnings, strong institutional ownership, positive earnings prices above guidance and reasonable price to earnings ratios.

Industry or sector leaders with incredible revenue growth and a dominant market position for the foreseeable future can lead to significant increases in stock price. But if the company loses that momentum and dominant market position the stock price could collapse. With all investments there is always the possibility of loss so make sure to only invest money you can afford to lose.