When the stock market is booming, the future looks bright and investors are more confident of solid returns from growth stocks.
However, when the stock market is trending down, moving sideways or just randomly bouncing around, it is harder for investors to feel confident about buying growth stocks for a future benefit.
If the economy is unsteady and investor confidence is low, investors are prone to avoid investments that have a pay off in the future.
Here are a couple of things to consider followed by more information on growth stocks:
- Not all stocks move with the stock market
- Even on down days in the market, there are stocks that reach new highs
- There is a big difference in picking stocks that may turn a profit this week and stocks that may prove good investments over the long term
Targeting growth stocks makes sense in any market, however you must always be careful in the selection process to focus on great companies and not potential quick gains. That's the difference between investing and trading.
The temptation to extend your risk tolerance levels can be strong when interest rates are low and investment returns uncertain. Avoid the temptation to take on more risk than is appropriate for your financial situation. That's an easy time to make bad mistakes.
What will the stock do tomorrow? Will the company continue to grow at a faster pace than the market in general?
These are typical of the questions growth investors ask about stocks they own. What is the companying going to do tomorrow - in earnings, revenue, sales and so on.
In a word, growth investors are all about the future and as such are very concerned with a company's prospects. Will this industry keep growing and will this company participate in that growth?
You don't have to be an expert on the industry, but it is important to do some reading online and in the financial press to help you identify which industries are growing.
How the Stock Fits
It is also important to understand how the industry fits into the economy and what factors could change that would slow growth in the future.
It probably is obvious that many growth industries are in or related to technology of some kind.
It would also be a good guess that many growth companies are small to mid sized.
However, there are a number of large companies that continue to be growth companies. Companies like Microsoft remained a growth company for many years.
The problem for large companies is maintaining a growth rate that keeps them in the category.
Do the Math
The math of percentage growth begins to work against them. It is one thing for a $100 million company to grow 20 percent - that's an additional $20 million in sales.
For a $10 billion company, that's an additional $2 billion in sales - a more difficult task if the company is in a competitive market. Do the math: If the company's average sale is $200 per unit (for software, for example), it will have to sell an additional 10 million units to grow sales 20 percent. Selling 10 million units of anything in a year is not something every company can do consistently and increase it for the next year.
A good growth candidate will be well positioned, although not always number one, in its industry with prospects for continued high growth rates.
Many growth investors want at least 20 percent year-to-year increase in revenue with a corresponding increase in earnings, but you will need to find your own comfort level and in an unsteady economy, 20 percent is probably unrealistic.
Questions about Growth
Questions growth investors must answer about a potential investment:
- The company, its financials, and its management - are they all positioned for sustained growth?
- Is the company in an industry likely to benefit from the current economic environment?
- How much should you pay for the stock?
Determining a good entry price for a strong growth stock can be difficult, but it is the most important factor in determining success.
Ideally, you will buy into a growth company early enough to profit from sustained growth.
However, if you pay too much of a premium for the growth potential, you may limit future profits.