Introduction – Growth Stocks
Growth stocks can be very powerful long-term investments. To be called a true growth stock I need to see a growth rate of 15% or higher. This growth should be seen in important metrics such as earnings, cash flows, and sales. The classic definition of growth stock tends to be vague and imprecise. For example, the website Investopedia offers these key takeaways:
“Growth stocks are those companies expected to grow sales and earnings at a faster rate than the market average.
Growth stocks often look expensive, trading at a high P/E ratio, but such valuations could actually be cheap if the company continues to grow rapidly which will drive the share price up.
Since investors are paying a high price for a growth stock, based on expectation, if those expectations aren’t realized growth stocks can see dramatic declines. Growth stocks typically don’t pay dividends. Growth stocks are often put in contrast with value stocks.”
Although these notions are helpful, I prefer a more precise definition. Mathematically, I will only consider a growth stock if it is growing earnings, sales, and cash flows of rates of 15% per annum or better. This is a rate of growth where the true power of compounding comes into play. All 3 of the companies: Meta Platforms (META), PayPal (PYPL), and Nvidia (NVDA) covered in this video meet those qualifications on a historical perspective. Nevertheless, the true measure of a growth stock lies in its future growth potential, which although related to the past is not always a realistic assumption.
Consequently, since growth stocks do not pay dividends, shareholder returns are totally a function of growth of earnings, cash flows, or sales which in turn drive growth of price. However, if that growth falters sometimes even ever so slightly, years of gains can disappear in an instant. The 3 examples covered in this video provide real-life case in point examples.
Therefore, in order to successfully invest in growth stocks, and investor needs to properly assess future growth within a reasonable degree of accuracy. Future forecasts do not have to be perfectly correct, but to succeed they must be generally correct.
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Disclosure: Long META, PYPL at the time of writing.
Disclaimer: The opinions in this document are for informational and educational purposes only and should not be construed as a recommendation to buy or sell the stocks mentioned or to solicit transactions or clients. Past performance of the companies discussed may not continue and the companies may not achieve the earnings growth as predicted. The information in this document is believed to be accurate, but under no circumstances should a person act upon the information contained within. We do not recommend that anyone act upon any investment information without first consulting an investment advisor as to the suitability of such investments for his specific situation.