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How to Choose Growth Stocks

A stock is considered a growth stock when it’s growing faster and higher than stocks of other companies with similar sales and earnings figures. Usually, you compare the growth of a company with growth from other companies in the same industry or compare it with the stock market in general.

If a company has earnings growth of 15 percent per year over three years or more and the industry’s average growth rate over the same time frame is 10 percent, then this stock qualifies as a growth stock. A growth stock is called that not only because the company is growing but also because the company is performing well with some consistency.

Here are some other important things to look at when considering growth stocks:

  • Fundamentals. This refers to the company’s financial condition and related data. When investors do fundamental analysis, they look at the company’s fundamentals: its balance sheet, income statement, cash flow, and other operational data, along with external factors, such as the company’s market position, industry, and economic prospects. The company should have consistently solid earnings, low debt, and a commanding position in the marketplace.

  • Value. Value stocks are stocks that are priced lower than the value of the company and its assets. You can identify a value stock by analyzing the company’s fundamentals and looking at some key financial ratios, such as the price-to-earnings ratio. If the stock’s price is lower than the company’s fundamentals indicate it should be (in other words, it’s undervalued), then it’s a good buy — a bargain — and the stock is considered a great value.

  • Leaders and megatrends. A megatrend is a major development that has huge implications for most (if not all) of society and for a long time to come. A good example of a megatrend is the aging of America. Federal government studies tell us that senior citizens will be the fastest-growing segment of our population during the next 20 years. How does the stock investor take advantage of a megatrend? By identifying a company that’s poised to address the opportunities that such trends reveal. A strong company in a growing industry is a common recipe for success.

  • Strong niche. Companies that have established a strong niche are consistently profitable. Look for a company with one or more of the following characteristics:

    • A strong brand: Companies that have a positive, familiar identity — such as Coca-Cola and Microsoft — occupy a niche that keeps customers loyal.

    • High barriers to entry: United Parcel Service and Federal Express have set up tremendous distribution and delivery networks that competitors can’t easily duplicate.

    • Research & development (R&D): Companies such as Pfizer and Merck spend a lot of money researching and developing new pharmaceutical products. This investment becomes a new product with millions of consumers who become loyal purchasers, so the company’s going to grow.

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