Growth Stocks – Features, Benefits and Alternative Investment Option
Growth stocks are issued by companies demonstrating a high potential for development. Purchasing shares of such companies can lead to massive wealth accumulation of investors through capital appreciation. However, growth stocks in India can be a risky investment venture, due to the developing nature of an issuing company.
Purchasing a growth stock is ideal for risk-prone individuals looking to gain massive returns on their total investment amount. Investors can easily identify the best growth stocks and their issuing companies by considering the following features:
- Price-to-earnings ratio
Companies having a high potential for development are identified in the market, and shares of the same have a high bid value. Issued growth stocks by these companies have a high price to earnings (P/E) ratio, indicating high returns on total investment.
A high price to earnings ratio indicates people’s recognition of the total potential of a company, expecting it to grow at manifold rates in the future. This ratio can be calculated using the following formula:
P/E ratio = Market value per share / Earnings per share
However, in certain cases, a high P/E ratio can be misleading, as it might indicate that a business is overvalued higher than its productive capacity. Performance of such businesses is a result of boom or persistent inflation in an economy or development of a financial bubble.
A preliminary requisite of best growth stocks in India is that they tend to have a ratio higher than or equal to 1.
- Price-earnings to growth ratio (PEG)
Due to specific limitations of P/E ratio, investors also look into price-earnings to growth ratio while distinguishing growth shares in India from a standard equity share. The main Advantage of PEG ratio over P/E ratio is that it takes into account the yearly rise in the total earnings per share of a business.
PEG Ratio = Market value of unit shares / Earnings per share growth rate
A high PEG ratio indicates exceptional performance demonstrated by a business. It is a better analysis tool when compared to the price to earnings ratio, as it does not produce misleading results.
- Strength of issuing business
Growth stocks can only be issued by companies having massive potential for growth and expansion in the future. This can only be achieved if a company has a strong foundation, with a solid business development plan and competent management to achieve stipulated targets.
It can be demonstrated through the return on equity (RoE) value published annually. Companies raising capital through growth stocks in India generally have a record return on total equity of 15% or higher annually.
Why Should You Invest in Growth Stocks?
- Higher returns
Investment in best growth stocks is undertaken to ensure wealth accumulation through large scale capital gains. Such companies exhibit a higher expansion rate than the underlying industry it is operating in, thereby ensuring larger revenue generated.
Profits through investment in growth stocks can only be realised in the long term. Any capital gains earned in this tenure is subjected to long term capital gains tax (LTCG), which is relatively lower than short term taxation policy. Also, a provision for indexation is present, reducing the tax burden of individuals even further.
- Hedge against inflation
Returns on best growth stocks are considerably bigger than the prevailing inflation rate in an economy, thereby allowing investors to generate real income on total investments. The purchasing power of individuals rises in the long run, effectively increasing their standard of living through a higher per capital income.
Risks Associated with Growth Stocks
Growth stocks are characterised as a risky investment venture. This is because these companies aim to generate profits by gaining a significant market advantage, through aggressive business strategies. Such companies tend to forgo on dividend payments for reinvestment for expansion purposes, which is a major disadvantage to investors.
In case a business churns out losses, in the long run, investors stand to lose out on total investment undertaken, as no dividend payments are realised during the lock-in period.
Growth stocks are generally issued by companies in its developing stage and therefore are highly susceptible in nature. They are heavily influenced by any market fluctuations due to their volatility. Even though this feature allows businesses to churn out massive returns during the market upswing, slight instability in price will lead to huge losses. Investment in best growth stocks should be undertaken depending upon market conditions.
The underlying performance of growth stocks can also be a result of the persistent economic condition in a country. In case a financial bubble is witnessed, any company functioning in that sector tends to over-perform beyond their potential. Such growth can be misleading, as it is based on an economic abnormality.
Therefore, investment in growth shares in India requires a comprehensive analysis of both chosen companies and prevailing socio-economic conditions for adequate generation of profits.
Alternative Investment Option
Value stocks –
As opposed to growth stocks, value shares are issued by companies currently undervalued in the market. These shares have a lower price to earnings and price to book ratio, proving to be a profitable investment venture for individuals.
Investors can gain through both dividend payments and capital appreciation from value stocks. Also, since value stocks are generally issued by companies having a considerable market capitalisation value, chances of undertaking a faulty investment venture are low.