There are many ways investors can make money and generate high returns in the stock market. One such reliable and profitable way is investing in growth stocks. Buying shares of these stocks can increase your chances of making money in the stock market. However, investors should not assume that investing in high-growth stocks in India will always offer high returns. Like other stocks, these growth stocks in India also carry a trade-off between gains and risks that must be considered before investing.
This article provides a detailed account of growth stocks and their key features to help investors invest wisely. Read on.
What Is a Growth Stock?
Growth stocks are mainly the stocks of companies or businesses that are more likely to increase their revenues or profits faster than other competitor businesses or the market. Such companies that increase their profits faster demonstrate a high potential for development and are also valued by stock exchanges in India.
In other words, purchasing stocks of such companies can enable investors to earn high returns and make exceptional capital accumulation. While these stocks are less risky because there is an understanding of the potential of the companies one is investing in.
Nevertheless, investors should keep in mind that the stocks of companies that tend to be growth-oriented are extremely volatile. This is why it is always wise to gain some familiarity with the fundamentals of these stocks.
Key Features of Growth Stocks
Growth stocks can be an ideal investment option for investors looking to gain higher returns with minimal risk. Investors need to closely understand the companies they wish to invest in to identify these stocks. Investors should look for certain features of companies that issue these stocks. Some of these features are:
Price-To-Earnings Ratio (P/E Ratio)
Price-to-earning ratio is a valuable indicator to identify these stocks quickly. Companies with a high growth potential tend to have a high price-to-earnings ratio.
A high P/E ratio equates to high returns on the total investment. Calculating a company's PER is fairly straightforward. Technically, the P/E ratio is the market value per share divided by the company's earnings per share. In some cases, a high price-to-earnings ratio can be misleading, as it could be that the company is overvalued in the market than its actual production capacity.
A high P/E ratio can also result from continued inflation in the economy or a false financial bubble. A general thumb of rule to identify the best growth stocks in India is to check if the company has a P/E ratio higher than or equal to 1.
Return on Equity Value (RoE Value)
Growth stocks are issued by companies that demonstrate higher potential for growth and development at present and in the future. High potential for growth can only be achieved if the company's foundation is robust and it has a solid developmental plan and skilled management that are clear on goals and targets. This can also be demonstrated with the help of the company's return on equity or RoE value. RoE value is published annually by companies. Companies that issue such stocks should have an annual RoE value of 15% or higher.
Price-Earnings to Growth Ratio (PEG)
The P/E ratio has certain limitations. One fundamental limitation is that the P/E ratio does not consider the annual rise in the total earnings per share of the company. That is why traders should also keep an eye on the price-earning-to-growth ratio of the company to distinguish growth stocks issuing companies from other average companies.
To calculate the PEG ratio, investors should use a simple formula that considers the market value of unit shares as divided by the company's earnings per share growth rate. A high PEG ratio indicates the company's excellent business performance. Unlike the P/E ratio, the PEG ratio is less vulnerable to producing misleading results.
Levels of Debt
Obtaining a high ROE is also possible by considering high amounts of debt. Thus, it is essential also to evaluate and research the debt and liabilities of the companies when identifying these stocks. The company's liabilities must be balanced with the ROE of the company. The debt levels of a company should be comparable to other competitor businesses.
Risks of Buying Growth Stocks in India
Investing in growth stocks can seem lucrative. However, such stocks come with their own sets of risks, such as a trade-off between return and risk. For example, the prices of these stocks can become highly volatile due to overvaluation or financial turbulence.
The common risk associated with purchasing growth stocks is the expected growth of such stocks may or may not continue in the future. In other words, investors may pay a high price for stocks expecting that they will receive high returns but may fail to receive them. Another factor that may impact the risks of investing in these stocks in India is turbulent market conditions, which may lead to price volatility.
Frequently Asked Questions (FAQs)
What is a growth stock?
A growth stock is a stock that is issued by a company that has a high potential for growth in the future. The company's growth means there is enough room for capital appreciation. Growth stocks allow investors to gain high returns with minimal risk. However, the risk may increase if the investors do not research the company before investing.
How can investors identify growth stocks?
Identifying growth stocks requires investors to thoroughly examine the company they are planning to invest in. Since these stocks are issued by companies that have high chances of developing and expanding in the future, there are certain factors that investors can research. For example, investors should check if the company has rising profit margins, strong sales growth, manageable levels of debt, and high returns on equity or RoE.
What are some popular examples of growth stocks?
Companies of all sizes issue growth stocks. Some popular large-cap companies that offer growth stock with the least risk are Amazon, Etsy, and Paypal. Some mid-cap companies that issue growth stocks are IDEXX laboratories, Roku, and Pinterest.
Why should I invest in growth stocks?
Whether or not growth stocks are the right investment option for investors depends on various factors. Investors who understand the market and the company they choose to invest in are more likely to reap benefits from investing in such stocks. In addition, these stocks are a better fit for those willing to undertake higher risks in exchange for their investment prices.