A growth stock is a share in a company anticipated to grow at a rate that’s significantly above the market average. Such growth stocks normally don’t pay dividends. These companies are expected to grow in value a lot, which is why they reinvest their earnings instead of distributing them. Unlike fast-paced CFD online, you earn money through capital gains eventually, when you sell your shares.
Finding good growth stocks can be daunting. To make the right call, you must first evaluate the stock.
Here are nine characteristics to look for in growth stocks before investing:
- Durable competitive advantage
High profits attract competition in business. However, the only way a company can maintain its profit margins and make them grow is through a sustainable competitive advantage. Companies with lasting advantages are usually limited but they are out there. They are either mid-sized or large organizations have a history of steady growth. They have a market share that offers them enduring advantages over all other players in the field.
- Diverse customer base
If the business depends on just a few customers, the competitive advantage of the stock isn’t of much worth. Good stocks are diverse businesses with an ever-expanding customer base. If such a company loses a customer, it doesn’t find itself in peril and instead continues to grow. That’s the kind of stock you should invest in.
- Recurring revenue
If a business has a good customer base and it enjoys recurring revenue, that’s the kind of stock that you should be interested in. Recurring revenue means sales that repeat automatically with the same customers. Often, such a company doesn’t even have to invest money in marketing or reinventing its products.
For instance, the revenue of Oracle recurs when customers renew their annual software licenses. Automotive companies like General Motors and Chrysler, on the other hand, collapsed during the recession of the 2000s. Companies of this type have to advertise and introduce new products to drive sales. They run expensive businesses and are vulnerable when the economy stumbles.
- Free cash flow
If a company’s stock has the above-mentioned values, it’s going to have a strong cash flow, too. This is the lifeblood of the company. It’s the cash a company earns from operations minus capital spending and other non-operational cash income. Generally, look for free cash flow that’s growing by 8 to 10 percent annually.
- Sensible share pricing
If you have to pay a higher price for it, even the best business in the world can prove to be a terrible investment. Since price is a variable factor, a stock purchased at a cheap price can result in significant wealth accumulation under the right conditions. Usually, strong companies implement a modest pricing model. They increase the price every few years without losing their customers.
- Capable of surviving tough stretches
Storms in capital markets don’t knock on your door before showing up – they just appear and wreak havoc on your financial life. Companies with good growth stocks have the financial strength to survive the darkest of days. Business might slow down, but their stocks won’t lose their worth.
- Hidden assets
The best growth stocks often have hidden assets that make a big difference in the long run. Examples of hidden assets include real estate and R&D spending. Tech companies spend huge piles of money on developing new practices and technology that can change the world.
- They don’t need acquisitions
Acquisitions can speed up the growth of a company, but at the same time, they add risks. This could undermine a safe investment. To avoid investing in companies that have grown through acquisitions.
- High Return on Equity
Warren Buffet says that Return on Equity (ROE) is the most important criterion for evaluating a company. It measures the profit generated through the money invested in the company by shareholders. Higher ROE means that management can allocate capital efficiently to generate returns for its shareholders.
A company that retains its profits for growth should be able to show how it uses its equity for generating high returns for its shareholders. If that’s not the case and the company’s ROE is poor, there’s no point in investing in it. Such a business won’t be able to generate returns for its shareholders.
More tips to follow
Growth stocks have been a part of the financial scene for nearly a century. Before investing in a stock, you need to understand the factors that made it profitable. These tips can help you make the right decision:
- Pick a company that has strong fundamentals, e.g. rising sales, strong earnings, and less debt.
- The company must belong to a growing industry.
- Participate in stocks that are benefiting from a bullish market.
- Continue to monitor your stocks. Hold on to stocks that have growth potential.
- Feel free to sell stocks that appear to be in decline.
The bottom line
Investing in growth stocks is a highly attractive strategy in a healthy economy. These stocks can certainly yield the greatest rewards, but they are also associated with their own set of risks that you need to watch out for. While selecting growth stocks to invest in, successful traders consult reliable financial service providers like Bernstein Bank. By learning how to identify the best stock growths, you can increase your odds of earning higher profits and diversifying your portfolio.