What is a ‘Growth Company’
A growth company is any company whose business generates significant positive cash flows or earnings, which increase at significantly faster rates than the overall economy. A growth company tends to have very profitable reinvestment opportunities for its own retained earnings. Thus, it typically pays little to no dividends to stockholders, opting instead to put most or all of its profits back into its expanding business.
BREAKING DOWN ‘Growth Company’
Growth companies are most often seen in the technology industries. The quintessential example of a growth company is Google, which has grown revenues, cash flows and earnings by leaps and bounds since its initial public offering (IPO). Growth companies such as Google are expected to increase profits markedly in the future, and thus the market bids up their share prices to high valuations. This contrasts with mature companies, such as utility companies, which see very stable earnings with little to no growth.
Growth companies create value by continuing to expand above-average earnings, free cash flow, and research and development spending. Growth investors are less worried about the dividend growth, high price-to-earnings ratios and high price-to-book ratios that growth companies face, because of the vast focus on sales growth and maintaining industry leadership. Overall, growth stocks pay lower dividends than value stocks because of the focus to reinvest profits in the business to help continue driving earnings growth.
Bull Markets Are Ideal Conditions for Growth Companies
During bull markets, growth stocks are preferred and tend to outperform value stocks because of the “risk on” environment and the perceived low risk in the markets. However, growth stocks tend to underperform value stocks during bear markets, as weak economic activity hinders sales growth and the growth engine driving the stocks higher.
Classic Growth Stocks: Google, Tesla and Amazon
The vast majority of growth companies reside in the technology sector, where rapid innovation and growth spending is commonplace. Google, Tesla and Amazon are three classic examples of growth companies because they continue to focus on innovative technologies, sales growth and expansion into new businesses, and heavily invest in their businesses.
While these three growth stocks have more expensive valuations than the S&P 500, Google, Tesla and Amazon are also the leaders in their respective niche industries. Google is continuing its technology conglomerate-status by expanding into new technologies such as artificial intelligence. Tesla is the popular electric car maker and undisputed leader of the emerging industry. Meanwhile, Amazon continues to disrupt the retail sector as it takes business away from traditional brick-and-mortar retail competitors.