People invest in stocks for two reasons: to have growth in net wealth, and/or to get regular income.
Growth in wealth depends on how the company is performing year after year. Based on its performance and demand, the price of the stocks goes up and down.
To grow wealth at a above average market rate, investors prefer to invest in growth stocks.
Growth stock is the company’s stock that grows faster and higher than the overall stock market. Here are certain characteristics of growth stock;
- Sales and earnings grow faster than other companies in the same industry.
- Make sure that the company is in a growing industry.
- The Company should be in business for at least 10-15 years.
- Understand how it makes profit.
- From where it generates sales.
Value stock vs Growth Stock
Don’t get confused between value stock and growth stocks.
A value stock is a company’s stock that is priced lower than the actual intrinsic value.
If you pick up any such stock, then in the long-term, it will give you a good return. You can find out value stock by analysing a company’s fundamentals such as P/E ratio, EPS, ROE, Debt to Equity, PEG and other financial tools.
Growth stocks are for 4-5 years.
Some people consider both growth and value are mutually exclusive as the main objective is capital appreciation. It’s also known as value oriented growth investing.
Here is a list of few world famous value and growth investors;
- Warren Buffett
- Benjamin Graham
- John Templeton
- Peter Lynch
- Rakesh Jhunjhunwala
- Radhakishan Damani
- Vijay Kedia
- Raamdeo Agrawal
- Motilal Oswal
These people have used value oriented growth investing over the years.
If you want growth in capital, then the first thing you need to know is how to analyse the company’s fundamentals.
Companies generate money year after year, which is known as profit or earnings. These surplus amounts generated can be distributed to stockholders in proportion to their investment. However, if the company’s expecting higher growth, instead of distributing dividends, they reinvest their net earnings back to the company. This way they fund their expansion or growth through internal funding.
People interested in growing their capital are generally interested in those stocks which are in their expansion phase. Which means they don’t pay dividends, instead the earnings generated are reinvested back into the company.
Growth stocks are riskier as they will be at their initial stage of expansion. They will not be having diversified established portfolios. Their business might take a hit in the case of economic downturn. Which means miss management and any adverse impact on their business, can wipe out your entire investment amount.
In the stock market the challenge is to find a stock which will make you richer. For this, you need to find value oriented companies with solid fundamentals that are well positioned themselves in the industry.
Compare stocks before picking up
Now, after using all your financial tools when you found a growth stock compare it with another company of the same industry. Preferably, with the same size.
For example, if your average industry growth is 10% but the company is growing at 15%, then it’s a growth stock of that industry.
Remember, growth in sales or earning must not be for a year. It must have constant growth.
How to check company’s fundamentals to find growth stock
You can check the company’s financial condition by using different financial tools, which is known as fundamental analysis.
To start your fundamental analysis, you need to gather information. You can gather information from various sources;
- Balance sheet,
- Income statement,
- Cash flow,
- Company’s market position,
- Industry, and
- Economic prospects
Find a company with strong niche
Company with one or two following characteristics is considered to have a strong niche;
- A strong brand
- Difficult for competitors to duplicate their business model.
- Investing on research and development
Shareholding pattern of the stock matters a lot. Stock price will go up only when it has high demand but less supply in the market. In other words, having more buyers than sellers of the stock.
If you find a stock which has not yet noticed by the market, then after buying, market attention could cause the stock price to climb. Remember, the reverse is also true.
Therefore, before buying, you must check the shareholding pattern to understand how market participants have position in it.
If any institutional investor or mutual fund takes interest in your stock, buying pressure can push the share price upward.
Don’t buy a stock on the basis of analyst’s recommendation. Do your own research before investing.
We have several parameters to find out the performance of the management.
One of the parameters to know how well the management is using the invested money in business to give you return can be measured by using the financial tool Return on Equity, known as ROE.
To calculate ROE, you need to divide earnings by equity. It will tell you how well the company is managing equity to generate money.
As a general rule, the higher ROE is better.
You can find company earnings from its income statement and equity capital from it’s balance sheet.