Evaluating Growth Stocks

Step 1: Where Do I Find Stocks With Above-Average Earnings Growth?

Evaluating Growth Stocks Splash image

A growth approach to investing can help you find stocks with the potential for significant price appreciation, provided the firm is able to meet and exceed its growth expectations and you don't overpay for growth. This strategy produces very little return in the form of dividends and can be volatile because of the large role that expectations play in the pricing of these stocks.

Company Characteristics

Classroom Steps

Growth companies expand at a rate above that of the overall economy. Practically speaking, however, the minimum benchmark for being classified as a growth stock is at least a 10% annual growth rate in earnings per share, with many investors requiring a 20% annual growth rate. To maintain growth rates this high over any extended period, capital spending is required, and for this reason growth stocks tend to retain most of their earnings, paying little or no cash dividends.

Promising growth stocks attract a great deal of attention, and therefore, prices tend to be bid up with high anticipation. High expectations relative to current levels of earnings lead to high price-earnings ratios, and it is not uncommon to see highly touted growth stocks with price-earnings ratios two to four times that of the market.

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