Growth stocks refer to the stocks of companies that are growing earnings and/or revenue more rapidly than its industry or the overall market. By not paying out any dividends, or distributing just a tiny amount, the firms use this tactic to instead reinvest retained earnings for further expansions. Most of the technology companies are growth stocks. [1 - 2]

If someone mentions growth stocks as attractive ones to buy, it's because of the potential earnings growth by its corporation. For a stock to be known as a "buy," its P/E ratio (price/earnings to growth) is relatively low among companies in its industry. Some people may dislike referring to this ratio, but it does disclose information about the market valuation of a company's earning. [3 - 4]

Excellent Examples of Growth Stocks

Apple (AAPL)

Google (GOOG)

P/E Ratio

To calculate a stock's P/E ratio, just simply divide the price-per-share of a company by its earnings-per-share. Here is an example: If company RSTU has a price per share of $60.00 and its earnings per share are $15.00, then the P/E for the company would be $4.00. In regards to interpreting the final arithmetic, four dollars indicates the amount of money investors are willing to pay for every $1.00 the firm makes in earnings. [4]

Many professionals in the industry use a certain method to pick out which grow stocks are worth considering or not. If the result for a company's P/E ratio is remarkably below $1.00, then it is considered to be sold at a lower price than the appropriate one. Hence, if the P/E ratio is remarkably greater than $1.00, then it is considered to be sold at a higher price than the appropriate one. [5]

Growth Strategy

Growth strategy is one to use when making investment decisions. It's basically just look at financial reports to see which businesses and sectors are growing significantly faster than their peers. Instead of rewarding investors for their trust by paying out dividends, companies distribute capital gains. Therefore, mutual funds that has the objective of achieving capital appreciation by buying shares of growth stocks. The theory about being involved with this type of stocks is the companies continuously increase their value so the funds get to collect the benefits of receiving large capital gain. Growth mutual funds are generally more volatile than other kinds of funds, which mean they fall more in bear markets and rise more than other funds in bull markets. [6]

Quick Notations

1. A growth company's stock is not always categorized as growth stock.

2. It is common that a growth company's stock is usually overvalued.

3. Most of the technology companies are growth stocks. [2]

An Investment Strategy

Growth at a Reasonable Price (GARP) refers to an equity investment strategy that attempts to unite the principles of both growth investing and value investing to find appropriate stocks for a portfolio. The investors look for companies that are demonstrating steady earnings growth above wide-ranging market levels (growth investing) while simultaneously avoid companies that have extremely high valuations (value investing). Without having pliant limitations for accepting or rejecting stocks, the overarching target is to avoid the inordinacy of either growth or value investing; this typically leads GARP investors to growth-oriented stocks with relatively low price/earnings (P/E) multiples in normal market conditions. [7]

Peter Lynch, a legendary fund manager at Fidelity, made GARP investing widely acceptable. This style originated the price/earnings growth (PEG) ratio that is now a fundamental metric that meet the requirements as a solid benchmark. The ratio shows the difference between a company's P/E ratio (valuation) and its expected growth rate earnings over the next several years. An investor would keep in mind to get hold of stocks that have a PEG of one or less so the person is informed which ones are being traded at reasonable prices. The one or less ratio points out that the P/E is in line with expected earnings growth. [7]

Fund managers of GARP look for inexpensive stocks of businesses that have been overlooked or ignored by market analysts. Moreover, some managers would also try to find moderately priced growth stocks by purchasing the ones that are rejected by momentum investors. Prices for these stocks usually lower due to reported disappointed earnings, or have other bad news to share. They certainly would buy only the ones that do have potential to increase their stock prices. [8]

In terms of being tax-efficient, it could be more advantageous to buy GARP funds because they are more inclined to have lower turnover rates than pure-growth fund. [8

During a bear market in stocks, one could expect the returns of investors following GARP to be higher than the ones that follow pure growth. Yet, the same investors also expect to have less than usual amount of returns in comparison to value investors that hunt for P/Es stocks that are under broad market multiples. [7]