What is the meaning of a growth stock?

A detailed explanation of what a growth stock is, the manner in which it differs from a value stock and a momentum stock and some examples of these three types of shares.

All stock prices do not move at the same rate. Some stocks shoot up very quickly while others move at a leisurely pace. This difference in the growth potential is what distinguishes a growth stock from a value stock. However, the distinction between growth and value stocks is not always very clear even in developed markets. In India, the difference is even less defined.

Growth stocks
Growth companies are those whose earnings (or net profits) are expected to grow at a faster pace than the market. Their shares, therefore, have the potential to rise faster than the market. Growth stocks usually have a high price to earnings (PE) ratio, indicating that they are overvalued. This is so because stock investors factor in the high growth rate that is expected of the company.

Investors in such stocks believe that the fast growth in profits will make the shares more attractive in the future and fetch a higher price. These stocks are often from relatively new companies in sunrise industries. These companies usually don’t pay dividends. Since they are in an expansive phase, they prefer to reinvest their earnings to make the business grow. Many listed Indian companies can be termed as growth stocks. Some typical examples are:

Value stocks
These are shares that are trading below their intrinsic value and are, therefore, considered good picks. Investing experts Benjamin Graham and Warren Buffett pioneered the concept of value investing. Value investors are bargain hunters on the lookout for such stocks. However, don’t mistake value stocks to be penny stocks which trade at below par prices.

Value stocks have a low PE and a low price to book value (PBV) ratio. Such stocks are also good dividend payers and have a healthy dividend yield. Value stocks could be from slow growing industries or from companies that are facing some problems which leads to a fall in their stock price. Although there are very few value stocks in India, here are some examples:

Momentum stocks
These stocks tend to rise very quickly when the market is on an uptrend. Momentum investors try to gain from an infectious surge in interest in such stocks. These stocks are marked by very high trading volumes. However, much of this is not delivery-based and is confined only to day trading.

Since a large number of investors are buying these stocks, one can make easy money by investing and selling these within a short period of time. But this amounts to timing the market, which can be very risky. A few examples of momentum stocks are: