What are Growth Stocks?

Growth stocks are the glamor investments on Wall Street. But unlike time-tested dividend growers or bargain-basement value plays, growth stocks carry plenty of risk.

They are the reason all those talking heads on CNBC have jobs, and what makes Jim Cramer ramble on as if he’s just chugged five Red Bulls (maybe he has). Growth stocks often outpace the market, and the best ones can earn triple-digit returns in a short amount of time. So it’s no surprise they generate so much excitement and endless chatter.

Of course, there’s a caveat to investing in growth stocks. The companies are less mature, often are subject to greater potential competition, and typically don’t pay a dividend. Thus, the stocks can be very volatile, especially around earnings season.

For many investors, however, the risks of investing in growth stocks are worth the potential rewards. Apple (AAPL), Amazon.com (AMZN), Netflix (NFLX)—all of them started off as growth stocks before they became some of the market’s most coveted stocks. Those who got in early earned triple-digit, even quadruple-digit, returns.

There are several keys to finding the right growth stocks:

• Invest in fast-growing companies. It’s a rather obvious prerequisite, but it’s important to know what fast-growing means. It means investing in fast-growing industries, where revolutionary ideas and services are being created. Any little-known stock that provides a product that is essential to that budding industry makes for a good growth stock. Rapid sales and earning growth is seen among most big winners before their stocks take off.

• Buy stocks that are outperforming the market. Companies can promise all kinds of financial growth, but is that growth potential translating to a rising share price? The best investing tips come from the performance of the stocks themselves; a rising stock tells you the smart money is accumulating shares.

• Use market timing. Never underestimate the power of the market to move stocks. You don’t want to invest in a growth stock just as the market is topping out, as three out of four growth stocks will follow the trend of the overall market. If you’re in a bull market, you can afford to be aggressive in buying stocks that are more speculative.

• Be patient. Not every growth stock will advance exactly when you want it to. Very few will, in fact. Even Apple had plenty of fits and starts on its way to becoming the most valuable company in the U.S. In the investment world, time is your friend. If you get out of a stock too early, you may miss out on some big gains months down the road.

Investing in growth stocks can be tricky. Finding a hidden gem that has yet to be fully discovered by the market is exciting, but requires lots of discipline to handle it correctly. Look for up-trending earnings growth, improving profit margins, and booming industries. If done right, investing in growth stocks can be both highly satisfying and highly profitable.

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