You may have heard of growth investing, but what exactly is a growth stock? Growth stocks are associated with successful companies that have the potential for faster than average growth in terms of revenues, earnings, or cash flow. With growth stocks, sometimes small dividends are paid to shareholders, but for the most part, retained earnings are reinvested.
While there is sometimes disagreement between companies when labeling their individual stocks, growth stocks all have some common characteristics:
• Strong growth rate, in terms of both historic and future projections
• High price-to-earnings (P/E) ratio
• High price-to-book (P/B) ratio
Growth stock investors are willing to pay more for growth stocks because they offer a promise of higher future returns, but past stock performance does not necessarily guarantee any future results. Although growth stocks have the potential to offer higher returns, they also bring greater risk when compared to value stocks. When stock prices are rising in general, growth stocks tend to do better than the overall market. However, when stock prices fall, these stocks often perform below average. This means that you should consider your tolerance for risk before investing in growth stocks.
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