Growth stock
In finance, a growth stock is a stock of a company that generates substantial and sustainable positive cash flow and whose revenues and earnings are expected to increase at a faster rate than the average company within the same industry.[1] A growth company typically has some sort of competitive advantage (a new product, a breakthrough patent, overseas expansion) that allows it to fend off competitors. Growth stocks usually pay smaller dividends, as the companies typically reinvest most retained earnings in capital-intensive projects.
Criteria
[edit]Analysts compute return on equity (ROE) by dividing a company's net income into average common equity. To be classified as a growth stock, analysts generally expect companies to achieve a 15 percent or higher return on equity.[2] CAN SLIM is a method which identifies growth stocks and was created by William O'Neil a stock broker and publisher of Investor's Business Daily.[3] In academic finance, the Fama–French three-factor model relies on book-to-market ratios (B/M ratios) to identify growth vs. value stocks.[4] Some advisors suggest investing half the portfolio using the value approach and other half using the growth approach.[5]
The definition of a "growth stock" differs among some well-known investors. For example, Warren Buffett does not differentiate between value and growth investing. In his 1992 letter to shareholders, he stated that many analysts consider growth and value investing to be opposites which he characterized "fuzzy thinking."[6] Furthermore, Buffett cautions investors against overpaying for growth stocks, noting that growth projections are often overly optimistic. Instead, he prioritizes companies with a durable competitive advantage and a high return on capital, rather than focusing solely on revenue or earnings growth.[7]
Peter Lynch classifies stocks into four categories: "Slow Growers," "Stalwarts," "Fast Growers," and "Turnarounds."[8] He is known for focusing on what he calls "Fast Growers" referring to companies that grow at rates of 20% or higher. However, like Buffett, Lynch also believes in not overpaying for stocks emphasizing that investors should use their "edge" to find companies with high earnings potential that are not yet overvalued.[9] He recommends investing in companies with P/E ratios equal to or lower than their growth rates and suggests holding these investments for three to five years.[8] He is often credited for popularizing the PEG ratio to analyze growth stocks.[10]
See also
[edit]- Alternate stock categorizations:
- Treatment of growth:
References
[edit]- ^ "Top Growth Stocks". InvestingDaily.com. Retrieved 2010-06-03.
- ^ "Sivy on Stocks". CNNMoney.com. 2004-08-06. Retrieved 2004-08-18.
- ^ O'Neil, William J. (2002). How to Make Money in Stocks: A Winning System in Good Times or Bad. The McGraw-Hill Companies. ISBN 978-0-07-137361-6.
- ^ Fama, Eugene F.; French, Kenneth R. (1998). "Value versus Growth: The International Evidence". The Journal of Finance. 53 (6). American Finance Association, Wiley: 1975–1999. doi:10.1111/0022-1082.00080. ISSN 0022-1082. JSTOR 117458. Retrieved 2021-12-28.
- ^ "Multi-Style Investing: A Tale Of Two Investment "Styles"". Bernstein Global Wealth Management. 2004-07-22. Archived from the original on 2012-09-07. Retrieved 2009-08-20.
- ^ "Chairman's Letter - 1992".
- ^ Buffett, Warren (1997). The Essays of Warren Buffett: Lessons for Investors and Managers.
- ^ a b Lynch, Peter (1989). One Up on Wall Street.
- ^ Lynch, Peter (1993). Beating the Street.
- ^ "Growth Investing with a Value Twist".
External links
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