Growth stocks: what are they?

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Personal Investing

We look at the definition of growth stocks and examine why they dominate the US stock market.

The global pandemic has changed our lives in so many ways. The human tragedy aside, it has accelerated many long-term themes regarding the way we carry out our day-to-day activities such as working remotely, online shopping, or connecting with friends and family via social media.

For investors, this change has resulted in the prices of some company shares – most notably, technology groups such as Facebook*, Apple*, Amazon*, Microsoft* and Google* (which is owned by Alphabet*) – rising in value to mirror our new lifestyles. Admittedly the share prices of these companies had been increasing before the pandemic, but COVID-19 has accelerated this trend.

Of course, growth stocks are not confined to any single area of the stock market – aside from technology you may find them scattered among food and drink companies, or healthcare groups. That said, they all share certain characteristics.

As the name implies, they are those companies which have potential for strong growth in the foreseeable future. They may currently be growing at a faster rate than many of their peers, or they may often devote much of the income they receive from selling their goods towards further expansion rather than paying their investors a dividend. As a result of their strong growth rate, they tend to command a greater value than some of their peers. Usually, but not always, they are associated with strong and recognisable brands.

Because growth companies tend to sell their goods irrespective of whether the overall economic backdrop is healthy or not, they’re typically seen as the direct opposite of value stocks. Generally, value stocks are those of more mature companies whose profits tend to be more sensitive to how well economies are faring.

Whereas in the UK and European stock markets, value stocks tend to dominate, in the US stock market, growth stocks are a big component. This is largely because of the presence of the US technology stocks we mentioned above. By contrast, the UK and European stock markets have very little exposure to technology stocks and tend to be focused around more established companies such as banks or car manufacturers.

Confusingly perhaps, growth and value ‘labels’ are sometimes interchangeable. During its lifetime a value stock may well become a growth stock if something has happened to the company which results in an increase in its rate of growth. This could be as a result of a new product or a new overseas market opening up.

Investors often question whether they should have their portfolios in growth or value stocks – both tend to perform differently under differing economic conditions. But whether you consider yourself a growth investor or a value investor, we believe that with interest rates at historic lows and little interest being offered on savings accounts, investing gives you the potential to aim for stronger returns over the long-term.

Remember, the value of any investment is not guaranteed. The value of investments and any income received from can go down as well as up and you may not get back as much as you had originally invested.

*For illustrative purposes only. The above information does not constitute a recommendation to buy or sell any security.