What is a Growth Company?
A growth company is any company that generates positive cashflows at a faster growth rate than the overall economy. Most of the time growth companies can operate within a specific sector that is increasing significantly and they tend to pay no dividends and instead reinvest to put most or all of their profits back into their expanding business.
Companies that fall under this umbrella create value by continuing to expand with outstanding earnings, free cash flow, and spending on research and development. Growth investors do not mind the non-dividend payments because they are getting rewarded from the increase of revenues since all the focus falls on the sales growth. This is what distinguishes them from value stocks that pay dividends but do not grow substantially like growth companies. Instead they maintain their value by being stable and well-established businesses.
Growth companies and the Overall Market Behavior
During bull markets, growth stocks tend to outperform value stocks because of the environmental risk and the inherent low risk that comes with a bull market.
During bear markets, growth stocks tend to underperform value stocks because the overall economy is considered weak and therefore risky. Sales growth is much slower in a bearish market and the sales growth is what drives the growth companies’ stocks higher.
Companies that pay dividends, also referred to as mature companies and tend to perform better in a bear market since they are stable with a more faithful consumer base. Mature companies also have stronger financials and larger cash reserves to use in order to withstand a weak economy if needed.
Growth companies Characteristics
- Strong management – The first step to every successful company is to hire the right team. Having a talented team with the appropriate experience in the industry helps businesses to move faster, be more transparent and aim for real growth.
- Break-through value proposition – A great product is vital to a high-growth strategy. Without the product, even the best team cannot go far.
- Competitive Advantage – Once the product is out there, it needs to be unique in order to differentiate it from competitors and attract more customers. It is also important that it will be scalable to continue its innovative expansion.
- Sustainable Competitive Advantage – It is not enough for a growth company to be growing. They have to possess a significant competitive advantage such as a lower cost structure, limited competition, and unique knowledge to keep it going.
- Taking Risks – Companies that are not afraid to take risks typically grow quite rapidly. The key is calculated risk that can be controlled. Failing to properly calculate risk is the main reason that companies fail.
- Proper Planning – Companies that pre-plan their steps are often going to last longer. They are also seeking for new opportunities to enforce their plans. They also plan ahead for potential changes that could impact and grow market share.
- Attention to the Marketplace – Paying attention to the economy and how is the overall market behaving is another key in building a business that can experience and sustain rapid growth. Companies that are too insulated and focus only on their own current market and their own current product line, run the risk of being stagnant.
Examples of Growth companies
Most of the growth companies operate within the technology sector where rapid innovation spending is involved. Let’s take for example Tesla (TSLA) and Amazon (AMZN) that are two classic examples. Both companies focus on continuous investment in innovation to better their product and therefore achieve increased sales and business expansion.
While these two growth stocks have more expensive valuations than the S&P 500, Tesla, and Amazon are also the leaders in their respective niche industries.
There are many small growth companies that exist in different sectors such as Bionano Genomics (BNGO) which provides a technology to detect genetic disease and cancer. The company has performed well and only recently has given back some of its returns due to the poor economy and bear market. Other companies are Square (SQ), Alibaba (BABA), MercadoLibre (MELI) Salesforce (CRM), Lemonade (LMND), and many more.
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