A “growth stock” refers to the shares of a company that is expected to grow at an above-average rate compared to other companies in the market. Growth stocks usually do not pay dividends, as these companies often reinvest retained earnings back into their businesses to accelerate growth in the form of new projects, acquisitions, research and development, etc.
Investors buy growth stocks with the expectation that they will earn a profit through capital gains when they sell the stock at a higher price in the future. Because these companies are in a growth phase, their stock prices can increase significantly in a short period of time, potentially leading to high returns for investors.
However, growth stocks also come with higher risk. Because investors are buying based on the expectation of future growth, if that growth doesn’t materialize, or if the company’s growth slows, the stock price can fall. In addition, growth stocks are often more sensitive to changes in the overall economy and market than other types of stocks.
Some famous examples of growth stocks, especially from the technology sector, include companies like Amazon, Google (Alphabet), and Tesla. These companies have demonstrated significant growth over time and have reinvested a large portion of their profits back into their businesses.
It’s important to note that while the potential for high returns is attractive, not all growth stocks will be successful, and investing in growth stocks should be balanced with other types of investments to manage risk.
Example of a Growth Stock
A well-known example of a growth stock is Amazon (AMZN).
When Amazon first went public in 1997, it was primarily an online book retailer. Since then, the company has expanded rapidly into numerous other sectors, such as retail goods, digital streaming, cloud computing through Amazon Web Services, and more.
Investors who recognized Amazon’s potential for rapid growth and bought the stock early on have seen significant capital gains. For example, if an investor bought Amazon’s stock at its initial public offering (IPO) price of $18 per share (split-adjusted), and held onto it, their investment would be worth a substantial amount today, as Amazon’s share price is well over $3000 per share as of September 2021.
However, it’s worth noting that while Amazon’s growth story has been impressive, not all growth stocks have the same trajectory. Investing in growth stocks involves considerable risk, as their future performance is often based on expectations, and any shortfalls in those expectations can lead to a drop in stock price. Therefore, a balanced and diversified investment strategy is typically recommended.