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  • Investing in Growth Stocks

    Updated: Oct. 5, 2020, 5:14 p.m.

    Investing in growth stocks can be a great way to earn life-changing wealth in the stock market. The key, of course, is to know which growth stocks to buy -- and when.

    To help you get started, here’s a handy guide to growth investing. With these tools and strategies, you’ll be able to position your portfolio for long-term success with growth stocks.

    What is a growth stock?

    Growth stocks are companies that increase their revenue and earnings faster than the average business in their industry or the market as a whole.

    Often a growth company has developed an innovative product or service that is gaining share in existing markets, entering new markets, or even creating entirely new industries.

    Businesses that can grow faster than average for long periods tend to be rewarded by the market, delivering handsome returns to shareholders in the process. And the faster they grow, the bigger the returns can be.

    Unlike value stocks, growth stocks tend to be more expensive than the average stock in terms of metrics like price-to-earnings, price-to-sales, and price-to-free-cash-flow ratios. Yet despite their premium price tags, the best growth stocks can still deliver fortune-creating returns to investors as they fulfill their awesome growth potential.

    Did You Know...

    Growth stocks are companies that increase their revenue and earnings faster than the average business in their?industry or the market as a whole.

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    Great growth stocks

    To provide you with some examples, here are 10 excellent growth stocks available in the stock market today:

    Company 3-Year Sales Growth CAGR Industry
    Shopify (NYSE:SHOP) 46% E-commerce
    Alibaba (NYSE:BABA) 35% E-commerce and cloud computing
    Square (NYSE:SQ) 43% Digital payments
    MercadoLibre (NASDAQ:MELI) 55% E-commerce
    Facebook (NASDAQ:FB) 24% Digital advertising
    JD.com (NASDAQ:JD) 25% E-commerce
    Netflix (NASDAQ:NFLX) 29% Streaming entertainment
    Amazon (NASDAQ:AMZN) 23% E-commerce & cloud computing
    Salesforce.com (NYSE:CRM) 30% Cloud software
    Alphabet (NASDAQ:GOOG), (NASDAQ:GOOGL) 17% Digital advertising

    CAGR = compound annual growth rate. Data sources: Morningstar, Yahoo! Finance

    As this list shows, growth stocks come in all shapes and sizes. They can be found in a variety of industries, both within the U.S. and in international markets. In fact, while all the stocks on this list are larger businesses, smaller companies can be fertile ground for growth investors, too.

    A great way to invest in a wide variety of small-cap growth stocks is via an exchange-traded fund (ETF) such as Vanguard Small-Cap Growth ETF?(NYSEMKT:VBK). This fund tracks the performance of the CRSP US Small Cap Growth Index, which gives investors an easy way to invest in roughly 580 small-cap growth companies all at once. Importantly, this ETF has an ultralow expense ratio of 0.07%, meaning that investors will receive nearly all of the fund’s returns, with only a small amount in fees going to Vanguard. (In fact, an annual expense ratio of 0.07% equates to only $0.70 in fees per $1,000 invested per year.)

    Watering can nourishing a trail of coins

    Image source: Getty Images

    How to find growth stocks?

    To find great growth stocks, you’ll need to:

    1. Identify powerful long-term market trends and the companies best positioned to profit from them
    2. Narrow your list to businesses with strong competitive advantages
    3. Further narrow your list to companies with large addressable markets

    Identify trends and the companies driving them

    Companies that can capitalize on powerful long-term trends can grow their sales and profits for many years, generating wealth for their shareholders along the way. Such trends -- and the companies that can help you profit from them -- include:

    • E-commerce: As more people shop online, Amazon and Shopify are well positioned to profit within the U.S. (and many international markets). Alibaba (NYSE:BABA) and JD.com (NASDAQ:JD), meanwhile, dominate e-commerce in China. And MercadoLibre (NASDAQ:MELI) holds a leading share of the online retail market in Latin America.
    • Digital advertising: Facebook (NASDAQ:FB) and Alphabet (NASDAQ:GOOG) (NASDAQ:GOOGL) own the lion’s share of the digital ad market and are poised to profit handsomely as marketing budgets shift from TV and print to online channels.
    • Digital payments: Square (NYSE:SQ) is helping to accelerate the global shift from cash to digital forms of payment by allowing businesses of all sizes to accept debit and credit card transactions.
    • Cloud computing: Computing power is migrating from on-premise data centers to cloud-based servers. Amazon’s (NASDAQ:AMZN) and Alibaba’s cloud infrastructure services help make this possible, while Salesforce.com (NYSE:CRM) provides some of the best cloud-based software available.
    • Cord-cutting and streaming entertainment: Millions of people are canceling their cable subscriptions and replacing them with less expensive and more convenient streaming options. As the global leader in streaming entertainment, Netflix (NASDAQ:NFLX) offers a great way to profit from this trend.

    The key is to try to invest in these types of trends and companies as early as possible. The earlier you get in, the more you stand to profit. However, the most powerful trends can last for many years and even decades, giving you plenty of time to claim your share of the profits they create.

    Prioritize companies with competitive advantages

    It’s also important to invest in growth companies that possess strong competitive advantages. Otherwise their competitors may pass them by, and their growth may not last long.

    Some competitive advantages are:

    • Network effects: Facebook is a prime example here. Each person who joins its social media platform makes it more valuable to other members. Network effects can make it difficult for new entrants to displace the current market share leader, and Facebook’s more than 2 billion users certainly make it unlikely that a new social media company will displace it.
    • Scale advantages: Size can be another powerful advantage. Amazon is a great example here, as its massive global fulfillment network is something its smaller rivals will find extremely difficult to replicate.
    • High switching costs: Switching costs are the expenses and difficulties involved in switching to a rival product or service. Shopify -- which serves as an online retail operating system for more than 1 million businesses -- is a great example of a business with high switching costs. Once a company begins to use Shopify as the core of its online operations, it’s unlikely to go through the hassle of switching to another competitor.

    Pinpoint companies with large addressable markets

    Lastly, you’ll want to invest in businesses with large addressable markets -- and long runways for growth still ahead. Industry reports from research firms like Gartner (NYSE:IT) and eMarketer -- which provide estimates of industry sizes, projections for growth, and market share figures -- can be very helpful in this regard. The larger the opportunity, the larger a business can ultimately become. And the earlier in its growth cycle it is, the longer it can continue to grow at an impressive rate.

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