Growth stocks provide a way to invest now in companies that may be poised for future success. While investors seeking regular dividend payments may wish to invest in income stocks, growth stock investing is a good choice for investors seeking share price appreciation. Rather than pay out sizable dividends, growth companies typically reinvest their earnings back into the business. Thus, growth companies' revenues and earnings are expected to increase more rapidly, which generally leads to share price appreciation. For a growth investor, current income is less important than a company's continued growth.
Emerging-growth companies are smaller and less well-capitalized than the average growth company. As they become larger, many emerging growth companies can't sustain their initial, very rapid rates of growth. Investors in emerging growth companies must have high risk tolerance and be willing to accept greater portfolio volatility than those who invest in income stocks or regular growth stocks.
Growth stocks frequently trade at price-to-earnings ratios that are significantly higher than those of the market as a whole. In other words, investors pay a substantial premium for stocks considered to offer above-average earnings growth potential. One of the challenges faced by growth stock investors is that it's often difficult to forecast earnings accurately. As a result, growth stocks tend to have extreme up-and-down price fluctuations if projected earnings are exceeded or if earnings are disappointing versus estimates.
Monitoring Growth Stocks
Investors usually want to review their growth stock holdings regularly to make sure the companies' prospects continue to justify premium price-earnings ratios. Often, by the time growth opportunities are recognized by the general public, stock prices have been driven up, and price-to-earnings ratios are no longer as attractive. As a result, the potential for further appreciation decreases.
In general, you only should consider growth stock investing if you're more interested in share price appreciation than income. If you're a conservative equity investor, you can participate in growth stocks by staying with high quality blue-chip names. If you're an aggressive investor, you can seek out opportunities among the smaller, emerging-growth companies. IBI