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SEPTEMBER 18, 2020

What is a growth stock?

Answered by
Nick Giorgi
Investment Strategist, Chief Investment Office, Merrill and Bank of America Private Bank
A growth stock is a share in a business that's shown above-average earnings and has the potential to grow faster than the overall economy. Because such stocks generally increase in price more quickly than other stocks, you may pay more for each share — based on what the company's current earnings are — than you would pay for the stock of a slower-growing company. If the stock's value increases, you can claim that value in the form of capital gains when you sell the stock. Because growth stocks tend to be relatively volatile, they are considered to contain some risk.
"Growth stocks tend to react faster to market swings, so you need to examine the risk of every investment you make."
— Nick Giorgi, Investment Strategist in the Chief Investment Office, Merrill and Bank of America Private Bank

Here are some key characteristics of a growth stock:

  • Higher price-to-earnings ratio than the broader market
  • High earnings growth record
  • Tends to be more volatile than broader market
  • Is often considered a riskier investment
  • Generally doesn't pay dividends to shareholders
Growth stocks tend to react faster to market swings, so you need to examine the risk of every investment you make. Before pursuing any investment strategy, it's also always a good idea to consider your investment time horizon — or how long you can leave the money invested — as well as your immediate cash needs. Investors willing to accept more risk may see better returns, but they also should be ready for bigger fluctuations.
A sector closely related to growth stocks is "emerging" growth companies, which include firms that have the potential to achieve high earnings growth, but do not yet have an established growth history.Footnote 1

What's the difference between growth stocks and value stocks?

While growth stocks can tend to be priced higher than the broader market, value stocks tend to be undervalued, or priced lower than one might expect, based on their fundamentals and the broader market. They also generally offer dividends — a key distinction between growth and value stocks.
A growth company typically reinvests its earnings into product research and expansion, instead of paying a percentage of its income to investors in the form of a dividend. When you invest in a growth stock, you're relying solely on potential gains from the increase in the value of the stock for your return on investment, rather than on a combination of these potential gains and income from dividends. Because of that — and the heightened volatility in growth stocks — your investment risk can be greater.
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Footnote 1 It is important to note that investing in emerging markets may involve greater risks than investing in more developed countries. In addition, concentration of investments in a single region may result in greater volatility.

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