Rewards in the stock market always come with risks. The greater the reward one wants, the greater the risk exposure to his/her investment.
Growth stocks generally belong to the young and growing companies, which are also riskier as compared to big, stable and mature companies. Investment in large, stable and mature companies is much safer but the returns are also in the same proportion.
The stock prices of such companies generally do not increase dramatically in a short period of time. On the other hand, this is quite a probable scenario in the case of small, young and growing companies.
Growth Stocks in India
There is no absolute formula that can help us in identifying these types of shares. It will always require some level of interpretation and correct judgment to select growth stocks for one’s portfolio.
Let us discuss some key indicators that may help us to identify growth stocks:
1. Earnings Per Share or EPS:
EPS has a direct correlation with the stock prices of a company. EPS is calculated by dividing profit after tax by the total number of outstanding shares.
EPS = Net Profit or Profit After Tax / Total Number of Outstanding Shares
As the EPS of a company increases, the stock price also appreciates. The EPS number should be compared with the last years’ EPS numbers.
There should be a track record of strong earnings growth over the previous five to 10 years. This is because if the company has shown good growth consistently in the last 5-10 years, it is likely that it will keep up the performance. Also, a comparison with peers in the same industry can also tell a lot about the financial performance of a company.
2. Competitive Edge:
Companies with high growth rates generally do have a certain kind of a competitive edge over their competitors. There can be many possible examples of this like –
Unique Product or Patented Technology – This gives a significant boost to the stock prices
Low-cost products – That may be because of several reasons like access to cheaper raw materials or more efficient processes and types of equipment or a better and more efficient distribution network.
Better Service Quality – This could be in terms of a better after-sales service network and customer-friendly warranty terms.
3. Growing Reserves of a Company:
Reserves of a company are what we get after subtracting dividend income from Profit After Tax. If there is an increase in reserve numbers over the last few years, it is a very positive and healthy sign for a company. That is because reserves show the ability of a company to be self-reliant.
Companies with good reserves do not have to depend on outside loans in order to meet their capital expenses and execution of expansion plans.
Therefore, they are saving a lot of costs related to debt, thus, increasing the overall profitability and thus, the stock price of a company.
It is one of the most important ratios to analyze the financial health of a company.
Debt is not necessarily a bad thing. In fact, in some industries, the lack of debt seems to be a negative sign as it shows a lack of proper expansion plans. A healthy debt to equity ratio is a good sign.
Although there is no fixed number that can be considered for all companies. The ideal figure for this ratio depends on the kind of industry a company is operating in.
For example, the debt to equity ratio of a sugar manufacturing company could be very different from an IT company. Therefore, this ratio should be compared with other peers in the same industry to make better sense.
5. Profit Margins:
The pre-tax profit margin of a company is calculated by deducting all expenses except taxes from the sale and dividing that by sales.
It is very important to look at this number because it is quite possible that the growth in sales of a company is excellent but gains in earnings are poor due to mismanagement of controlling costs and revenues.
This could be an indicator of inefficient management systems and is definitely a red flag on the financial statements of a company. The higher the pre-tax profit margin, the more profitable the company.
The pre-tax profit margin figures of a company should be compared with the figures for the last few years in order to know the direction of the company’s profitability.
Return on equity (ROE) or Return on Net Worth (RONW) is the amount of net income returned as a percentage of shareholders’ equity. It is a measure of a company’s profitability by taking into account the amount of money its shareholders have invested in.
Return on Equity = Net Income / Shareholder’s Equity
This number should be compared with peers in the same industry as it indicates the effectiveness of converting the cash put into the business into greater gains and growth for the company and its shareholders.
The higher the return on net worth, the more efficient the company’s operations are making use of those funds.
Some of the fastest-growing companies in India in the year 2018 are –
Minda Industries Ltd.
Safari Industries (India) Ltd.
Avanti Feeds Ltd. HEG Ltd.
Bajaj Finance Ltd.
Pondy Oxides & Chemicals Ltd.
GM Breweries Ltd.
Aksharchem (India) Ltd.
Since every coin has two sides, the risk factor also comes while investing in growth stocks.
The risk involved with investing one’s hard-earned income in growth stocks is that since there is almost no income through dividends (learn how to invest in dividend stocks for more information), the investors have to depend only on the good increase in the prices of their stocks.
If by any chance, that does not happen due to a certain amount of unpredictability always involved in the stock market, the investor may have to bear losses when they sell their stocks.
Growth Stocks Risk
Obviously, when you invest in the stock market, there is a relatively higher amount of risk involved. Having said that, when you are talking about growth stocks, the risk is not as straightforward as it may seem.
For instance, if there is any specific negative news hovering around the circuit about the industry, or any new government policy that directly or indirectly impacts the sector the stock is from, etc, there is going to be a sudden drop in the price of the stock.
However, since the stock is fundamentally strong, the life of that risk is going to be short-lived and its price is going to get back or let’s say rebound pretty soon.
The stock is going to be much less sensitive due to the overall economic conditions and is going to provide returns in the long term.
Growth Stocks Returns
Let’s talk about the crux of this piece, the heart of the story – the returns on your investment!
Well, congratulations first of you, if you were able to crack a growth stock or two in your portfolio. These companies might not pay you any dividend for they look to reinvest their profits back to the business.
However, this is the primary reason as well that they come out and stay as a growth stock in the business.
Thus, stay for a long haul and you are looking at a sizable return on your investment. Sometimes, in the multiple of what the general market tends to offer to its investors.
Only disinvest if you are in real need of money and have exhausted other possible sources. The holding period in the case of growth stocks is generally 10 years+.
Growth Stocks Examples
Although, we are going to give you a few examples of the latest growth stocks.
However, it makes total sense for you to perform a detailed fundamental analysis of stocks before you go ahead with your investment. This is for the simple reason that if such tips were available so easily, then everybody would have been investing in growth stocks.
And of course, most of the businesses would have copied the patterns of a growth stock and one day, most of the stocks would have been growth stocks.
Anyway, here are a few growth stock examples for your reference:
Jamna Auto Industries
PE Ratio: 21.63
Net Profit Growth in 3 Years: 62.17%
Upside Potential: 40%
PE Ratio: 15.24
Net Profit Growth in 3 Years: 32.23%
Upside Potential: 53%
PE Ratio: 15.59
Net Profit Growth in 3 Years: 41.94%
Upside Potential: 40%
PE Ratio: 14.96
Net Profit Growth in 3 Years:: 79.71
Upside Potential: 18%
PE Ratio: 18.10
Net Profit Growth in 3 Years: 21.07
Upside Potential: 11%
PE Ratio: 22.33
Net Profit Growth in 3 Years: 40.16%
Upside Potential: 29%
The PE Ratio of all these stocks is pretty well placed in their specific sectors as compared to their peer companies. At the same time, these businesses have shown a consistent increase in their year net profit.
Furthermore, based on the fundamentals and the historical performance, the analysts from relevant financial houses such as economic times believe there is a reasonable amount of upside potential investing in these stocks.
Having said that, we would like to repeat that it makes complete sense for you to confirm these stocks based on your own analysis first before you invest in these stocks.
So, now we know that growth investors believe in investing in those stocks which are going to reward them with a great increase in the stock prices in a relatively short period of time.
Growth investing does not focus on companies that are consistently giving dividends to their shareholders but the increase in stock prices is not that impressive. In order to identify growth stocks, one must try to find companies that are unique in some or another way.
In simpler words, growth investors look for companies that have some kind of competitive edge in terms of cheaper and better quality products, patented technology, or better after-sales service and customer-friendly policies.
In identifying growth stocks, one must also befriend the financial statements of companies and have a good grasp over different financial ratios used to compare the company’s growth rate with itself over the last few years and also to compare growth rate with its competitors of the same industry.
One must also look at the management of the company and try to find its effectiveness by reading the management discussion and analysis of the company’s performance over the last few years.
That indicates whether the company management is aware of any problems being faced by the company or not.
It should also be seen how efficiently the management is solving the problems and if it is able to keep up the promises to its shareholders. Even after all the analysis, sometimes, things can take a downturn and stock prices may not move in the desired direction.
There is always an element of risk involved in investing in stocks. Growth stocks are risky in the sense that the only way investors can earn by investing in them is through a significant stock price rise. No dividend income is expected out of growth stocks.
Therefore, the risk of losing money remains in adverse situations.
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