Growth stocks are one of the types of stocks that adhere to the principles of growth investing. These stocks can give investors the highest potential gains in their investments. However, with thousands of stocks to choose from and the fact that investing in small-cap stocks and mid-cap to large-cap stocks all have the potential for sizeable growth, identifying and choosing the right growth stocks can be tricky for beginners.

A Guide to Choosing and Investing in Growth Stocks

1. Know the Characteristics of a Growth Stock

Remember that growth stocks are issued and traded by companies with a high potential for growth. These stocks are expected to outpace other stocks in terms of performance and overall appreciation as determined by their stock prices. What exactly are growth stocks and what set them apart from other stocks? The following are the key characteristics of growth stocks and growth companies:

• Low or Zero Dividends: Most growth stocks do not pay dividends while some have low dividends. Furthermore, most growth companies tend to issue common stocks instead of preferred stocks. These growth companies prefer reinvesting their earnings and profits to accelerate and maximize their growth potential.

• Impressive Growth Rate: Another notable characteristic of growth stocks is that their stock prices tend to appreciate at a rate higher than the entire stock market or specific stock indices. The short-term historical prices of these for a period of 10 years or less show a growth rate of between 10 to 20 percent or more.

• Higher EPS and P/E Ratio: Growth stocks also demonstrate higher earnings per share or EPS and price-to-earnings ratio than other stocks such as value stocks. Their higher EPS comes from the fact that the profits of issuing companies are growing faster while their high P/E ratio demonstrates high demand from investors.

• Small-Cap to Large-Cap Stocks: Most growth stocks are small-cap and mid-cap stocks. However, some large-cap stocks can also be considered growth stocks. The key to determining which stocks have the highest growth potential is to look at pertinent data from the fundamentals of the issuing companies.

2. Look for Companies with Growth Traits

Furthermore, aside from knowing the key characteristics of growth stocks, identifying and choosing growth stocks also involve looking for the so-called growth traits of prospective companies. Take note of the following:

• Strong Management and Leadership: Companies with the potential for higher and faster growth tend to have a solid business model designed and deployed by a competent team of managers. Growth companies have a strong management and leadership culture that can be observed based on their publicized and digestible strategic directions and impressive and transparent financial records.

• Operate in Active and Promising Industries: Another characteristic of growth companies is they operate in industries or sectors poised for growth. Some of these industries or sectors are already established and have reached a certain level of maturity but remain active and dynamic due to innovation. Other are emerging industries and sectors that are disrupting or have the potential to disrupt the markets.

• Large Target Market or Customer Base: The revenue and profit potentials of companies can be determined by the size of their target market. A large market indicates a higher probability of generating sales. Smaller markets or niches are limited in providing higher revenues and profits. However, emerging markets still have the potential to become large markets in the future.

• Commanding or Sizeable Market Share: Companies can compete in large markets with low barriers to entry. However, this does not mean that they are growth stocks. Another way to determine growth stocks is to see if the issuing companies have captured a sizeable portion of the market. Their market share need not be the largest but still has enough portion and potential to expand in the future.

• Existing and Demonstrated Competitive Advantage: Another key trait of growth companies is a competitive advantage over other companies. This may include economies of scale or innovation or strong research and development. Competitive advantage gives them an edge over their competitors when it comes to differentiating their products or ensuring that their operations are as cost-efficient as possible.

• Loyal Customers and Strong Sales Growth: Growth companies also tend to have an emerging or established following of loyal customers. These customers ensure that their upcoming products would be consumed or purchased. Furthermore, growth companies have demonstrated strong sales growth each year through their consistent introduction of new products, innovation, and even rebranded products.

Research plays an important role in choosing growth stocks. The largest companies of today started as startups and small companies. However, not all startups and small companies have the potential to become large companies. It is important to reiterate the fact that even medium-sized and large-sized companies can be considered growth stocks.

Growth investors are informed investors who use fundamental analysis, technical analysis, and market research. They look for the aforementioned characteristics of growth stocks and traits of growth companies in a thorough manner as possible. Research can take a considerable amount of time and effort. It can also incur costs. But it is essential in growth investing.

3. Buy and Hold Your Growth Stocks

Investing in stocks has advantages but also disadvantages or drawbacks and risks. Growth stocks have pros and cons themselves. Growth investing does not provide immediate gains. Some gains are even negligible. However, the key to successful growth investing is time and patience.

Remember that large companies started as small startups and those who have invested in them saw their growth potential. Investing in growth stocks does not end with choosing them. It requires a buy-and-hold strategy or an almost invest-and-forget mindset. Most growth investors adhere to a passive investment strategy while allowing room for adjustments.