Growth stocks collectively represent one of the several types of stocks categorized based on the involved investment strategy. Investing in these stocks demonstrates adherence to the principles of growth investing. Companies that issue growth stocks are anticipated to increase their sales and grow their revenues at a phase faster than the market average.
Understanding the Pros and Cons of Investing in Growth Stocks
Advantages of Growth Stocks: Reasons Why You Should Invest
Several small-cap stocks are also considered growth stocks. Some large-cap stocks or larger companies are also considered growth stocks. Investing in these stocks comes with an expectation that the overall investment will outperform the stock market or common stock indices and that earnings will be generated through capital gains or the appreciation of the stock prices. The following are the specific advantages of growth stocks:
• Higher Growth Potential: Growth stocks are often pitted against value stocks. The same is true for growth investing and value investing. Nevertheless, between the two, growth stocks have a higher potential for growth. These stocks often outperform the overall stock market and the issuing companies often beat third-party estimates.
• Bigger Investment Returns: Another advantage of investing in growth stocks is the potential for bigger returns due to the gradual but higher potential for capital appreciation. This advantage is similar to the benefits of small-cap and mid-cap stocks. Investors can meet their bigger target through growth investing.
• Large-Cap Stock Potential: Companies such as Walmart and Microsoft started as small-cap growth stocks. This means that investing in and holding current growth stocks have the potential to generate a considerable amount of wealth. A one-time or single placement investment can mean a big win in the future.
• Affordable Stock Prices: Investing in growth stocks does not require a huge capital investment although they often trade at a higher price-to-earnings ratio. Most of them have lower stock prices compared with most large-cap stocks. This is especially true for small-cap stocks or the stocks of small and emerging companies.
Disadvantages of Growth Stocks: Reasons Why You Should Not Invest
Note that investments with higher potential returns come with higher potential risks. The risk-return tradeoff characterizes the central disadvantage of growth stocks. Some consider value stocks as safer bets but others would argue otherwise. The following are the specific disadvantages and risks of investing in growth stocks:
• Most Do Not Pay Dividends: Most growth stocks do not pay dividends because their issuers prefer reinvesting their earnings and profits to accelerate and maximize their growth potential. This can be a drawback among investors seeking to generate a passive stream of income from their investment portfolio.
• Higher Risks Than Value Stocks: Investing in stocks comes with higher risks and growth stocks are even riskier than more conservative stocks. Most of these risks are similar to the risks associated with small-cap and mid-cap investing. Hence, these stocks are not suitable for investors with lower risk tolerance.
• Negligible Short-Term Return: Another disadvantage of growth stocks is that they a require long-term investment mindset. The returns are minimal or negligible in the short term. They are ideal for buy-and-hold strategy or passive investing while unsuitable for investors seeking to generate profit as fast as possible.
• Dependent on Capital Appreciation: There are three ways investors can earn from stocks: through price appreciation, dividend payouts, and trading or active investing. Growth stocks are limited to capital appreciation. Failure to meet the expected appreciation often results in dramatic declines in their stock prices.
• Requires Thorough Research: It can be difficult to pinpoint growth stocks that have the potential for bringing in maximum returns. There is limited market information regarding small-cap companies and startups. Investors need to spend either time researching about a particular growth stock or money paying advisors or analysts.