finance Finance refers to monetary resources and to the study and Academic discipline, discipline of money, currency, assets and Liability (financial accounting), liabilities. As a subject of study, is a field of Business administration, Business Admin ...

, a growth stock is a

stock Stocks (also capital stock, or sometimes interchangeably, shares) consist of all the Share (finance), shares by which ownership of a corporation or company is divided. A single share of the stock means fractional ownership of the corporatio ...

of a company that generates substantial and sustainable positive

cash flow Cash flow, in general, refers to payments made into or out of a business, project, or financial product. It can also refer more specifically to a real or virtual movement of money. *Cash flow, in its narrow sense, is a payment (in a currency), es ...

and whose

revenue In accounting, revenue is the total amount of income generated by the sale of product (business), goods and services related to the primary operations of a business. Commercial revenue may also be referred to as sales or as turnover. Some compan ...

s and

earnings {{Short description, Financial term Earnings are the net benefits of a corporation's operation. Earnings is also the amount on which corporate tax is due. For an analysis of specific aspects of corporate operations several more specific terms are u ...

are expected to increase at a faster rate than the average company within the same industry. A growth company typically has some sort of

competitive advantage In business, a competitive advantage is an attribute that allows an organization to outperform its competitors. A competitive advantage may include access to natural resources, such as high-grade ores or a low-cost power source, highly skille ...

(a new product, a breakthrough patent, overseas expansion) that allows it to fend off competitors. Growth stocks usually pay smaller

dividend A dividend is a distribution of profits by a corporation to its shareholders, after which the stock exchange decreases the price of the stock by the dividend to remove volatility. The market has no control over the stock price on open on the ex ...

s, as the companies typically reinvest most

retained earnings The retained earnings (also known as plowback) of a corporation is the accumulated net income of the corporation that is retained by the corporation at a particular point in time, such as at the end of the reporting period. At the end of that per ...

in capital-intensive projects.

Criteria

Analysts compute

return on equity The return on equity (ROE) is a measure of the profitability of a business in relation to its equity; where: : Jason Fernando (2023)"Return on Equity (ROE) Calculation and What It Means" Investopedia Thus, ROE is equal to a fiscal year's net in ...

(ROE) by dividing a company's net income into average

common equity Common equity is the amount that all common shareholders have invested in a company. Most importantly, this includes the value of the common shares plus retained earnings and additional paid-in capital. History Under the Basel III banking agreement ...

. To be classified as a growth stock, analysts generally expect companies to achieve a 15 percent or higher return on equity.

CAN SLIM CAN SLIM is an acronym developed by the American investor William O'Neil, intended to represent the seven characteristics that top-performing stocks often share before making their biggest price gains. The method was named the top-performing inve ...

is a method which identifies growth stocks and was created by

William O'Neil William Joseph O'Neil (March 25, 1933 – May 28, 2023) was an American businessman, stockbroker, and writer. He founded the stock brokerage firm William O'Neil & Co. Inc in 1963 and the financial newspaper '' Investor's Business Daily'' in 19 ...

a stock broker and publisher of ''

Investor's Business Daily ''Investor's Business Daily'' (''IBD'') is an American newspaper and website covering the stock market, international business, finance, and economics. Founded in 1984 by William O'Neil as a print newspaper, it is owned by News Corp and headquar ...

''. In academic finance, the

Fama–French three-factor model In asset pricing and portfolio management, the Fama–French three-factor model is a statistical model designed in 1992 by Eugene Fama and Kenneth French to describe stock returns. Fama and French were colleagues at the University of Chicago Boo ...

relies on

book-to-market ratio The price-to-book ratio, or P/B ratio, (also PBR) is a financial ratio used to compare a company's current market value to its book value (where ''book value'' is the value of all assets minus liabilities owned by a company). The calculation can b ...

s (B/M ratios) to identify growth vs. value stocks. Some advisors suggest investing half the portfolio using the value approach and other half using the growth approach. The definition of a "growth stock" differs among some well-known investors. For example,

Warren Buffett Warren Edward Buffett ( ; born August 30, 1930) is an American investor and philanthropist who currently serves as the chairman and CEO of the conglomerate holding company Berkshire Hathaway. As a result of his investment success, Buffett is ...

does not differentiate between value and growth investing. In his 1992 letter to shareholders, he stated that many analysts consider growth and value investing to be opposites which he characterized "fuzzy thinking." Furthermore, Buffett cautions investors against overpaying for growth stocks, noting that growth projections are often overly optimistic. Instead, he prioritizes companies with a durable competitive advantage and a high

return on capital Return on capital (ROC), or return on invested capital (ROIC), is a ratio used in finance, valuation and accounting Accounting, also known as accountancy, is the process of recording and processing information about economic entity, economi ...

, rather than focusing solely on revenue or earnings growth.

Peter Lynch Peter Lynch (born January 19, 1944) is an American investor, mutual fund manager, author and philanthropist. As the manager of the Magellan Fund at Fidelity Investments between 1977 and 1990, Lynch averaged a 29.2% annual return, consistently m ...

classifies stocks into four categories: "Slow Growers," "Stalwarts," "Fast Growers," and "Turnarounds." He is known for focusing on what he calls "Fast Growers" referring to companies that grow at rates of 20% or higher. However, like Buffett, Lynch also believes in not overpaying for stocks emphasizing that investors should use their "edge" to find companies with high earnings potential that are not yet overvalued. He recommends investing in companies with P/E ratios equal to or lower than their growth rates and suggests holding these investments for three to five years. He is often credited for popularizing the

PEG ratio The 'PEG ratio' ( price/earnings to growth ratio) is a valuation metric for determining the relative trade-off between the price of a stock, the earnings generated per share (EPS), and the company's expected growth. In general, the P/E ratio is ...

to analyze growth stocks.

References

External links

How to Find the Ultimate Growth Stock
Fundamental analysis Stock market {{finance-stub

Criteria

See also

References

External links