Our Pick Of The Best Growth Stocks For Australians

Growth stocks are companies that are growing sales or earnings faster than the market rate in aggregate. They are able to ramp up revenue much quicker than older or more traditional stocks that may already be entrenched in their industries.

Over the medium to long term those sales result in realisation of profit that is far in excess of the growth in the economy or in the wider equity market.

Generally, growth stocks share a few distinct characteristics. They often tend to be newer companies that rely on some innovation or unique product to stay ahead of competitors.

They generally have a story or a theme behind them. For example, the current trend of electric vehicles or artificial intelligence that could significantly change how the world functions.

Growth stocks are also able to take advantage of or organically grow a large addressable market. For example, Uber was able to take advantage of the sclerotic taxi industry while chipmaker Nvidia has ridden the AI trend over the last year to record spectacular growth.

“These are companies where you’re expecting the share price to deliver the bulk of the investor returns over the medium to long term,” UBS equity strategist Richard Schellbach says.

“That contrasts with more mature companies where you’re more likely to get a dividend every six months that would ultimately contribute to total investor returns.”

That is often the case because growth stocks are generally capital hungry and find it more appropriate to reinvest earnings back into their business rather than pay out a dividend to the investors, Schellbach adds.

Growth stocks may not be a good buy in all scenarios, says Matt Wacher, chief investment officer for Asia Pacific at Morningstar. Investors need to analyse the fundamentals of these companies to understand their business and the investing theme that will help them to win market share.

“But, if they’re too expensive, it doesn’t matter how good a company they are. If they’re trading on a multiple that you can’t see is achievable, then it’s unlikely you’re going to make money out of those companies,” he says.

In such cases, investors would be better placed being patient because a lot of growth company stocks tend to be highly volatile.

Companies in this segment also come with some other inherent risks.

The nature of growth businesses involves risks because they tend to be in less mature industries, often with less-proven business models, according to UBS’ Shellbach.

The other risk for growth investing is that the companies you’re buying on growth characteristics involve profitability over a long-term time horizon, which may or may not materialise. If the company doesn’t meet those expectations, there’s a big risk of a very large sell-off, especially because these stocks generally trade on more expensive multiples.

“It really depends on your investment horizon and appetite for risk,” Shellbach says.

Under the traditional method of constructing an equity portfolio, growth stocks are considered appropriate for a younger investor who is more willing and able to take risk because they’ve got the time horizon to do that.

By contrast, people who are approaching an age where they want to start accessing predictable income streams or those who need to draw down capital for a specific purchase, may want to steer clear of growth stocks, Shellbach says.

How To find Growth stocks

The best way to find growth stocks involves picking out market trends that will prove beneficial over the long-term and the companies best positioned to profit from them.

“A lot of it has to do with identifying the areas of the economy that are likely to capture growth,” Shellbach says.

In previous decades, that could have been the adoption of the personal computer and then the iPhone. Right now, AI-related themes are dominant and medical devices or drugs have also proven to be fertile ground for growth companies.

“Within that, it’s really being able to work out the companies that are likely to achieve those growth ambitions versus those that are less likely to achieve this.”

In order to compile our list of best growth stocks, we looked at a number of key metrics:

• The nature of the business and whether it’s at the forefront of a booming sector.
• The future prospects of the sector: whether it’s peaked or is likely to sustain more growth.
• How the company has performed over the past year.  What was its one-year return?
• How the company performed over the past five years. It is not uncommon for growth stocks to hit five-year growth levels of 1,000%. All of the companies on our list increased their value by more than 100% in five years.

Investors sometimes confuse growth stocks with value stocks but the two categories are quite distinct.

Growth stocks tend to be newer, innovative businesses that are growing rapidly but which may or may not be profitable. On the other hand, value stocks are generally big, cyclical kinds of businesses such as oil companies or banks which may be trading at a discount at different points in time.

“Value stocks are not always cheap, but potentially you’re looking at buying something cheaper than what its intrinsic value is,” Morningstar’s Wacher says.

Another key difference is in terms of track record and dividend history.

Value stocks may have a long track record which enables investors to identify the fundamentals by the underlying cash flows of the business. You can assess the fundamental fair value by making some assumptions but there is also a long history of cash flows that have been generated over different times in different periods.

Wacher says of value stocks: “You can understand how the dividends or buybacks are going to be paid to investors, you understand how those dividends and buybacks are going to grow and you can do a discounted cash flow and work out where the company should be valued.”

On the other hand, a growth company may not have been around for very long. They generally don’t have a long history of the cash flows they can generate. While a value investor relies on past history, a growth investor will look to the potential of the business in future.

For the most part, growth and value stocks trade counter to one another but they can occasionally converge in certain stocks that display an element of both. Such stocks are referred to as growth at a reasonable price (GARP) where a high growth stock is available at valuations that are not outrageously expensive.