Competitive Advantage is key to all Growth Stocks.
A growth stock is a stock that is expected to perform at an above average rate relative to the market. It is anticipated to have growth that is much higher than the average company will in that market. There may be many companies that come to your mind as you try to understand the definition of a growth stock versus a value stock. Remember, a value stock is defined as a company that has good fundamentals but is priced below those if its peers.
Growth or Value?
Value stocks are companies that tend to be “mature” companies. A mature company, being one that has been around a while and clearly is a valuable company. Now on the other hand, growth stocks tend to be new companies and have hit the scene with some sort of competitive advantage. This competitive advantage is what is distinguishing it as a growth stock and company. You see this company as something that may be futuristic or is doing business in some type of way or manner that similar companies never thought about.
One thing to keep in mind, is that not all growth stocks are newer companies. There are exceptions to this case. One being Apple. A quick example and timeline to show this is… Apple went public in 1980. In 1995, Apples Price to Earnings (PE) Ratio was 10x. Now lets fast forward to 2003, Apple had a PE Ratio of 50x, 23 years after going public. Which means 23 years later, Apple was being viewed as a growth company. Looking back at it now and seeing what Apple has done and continues to do, you can see how this was possible.
Now there are some key competitive advantages to keep an eye on when categorizing a company as either growth or value. Some of the competitive advantages may be a new product, some type of patent, great process, innovative plan or great service. Those may seem broad, but when you compare those indicators to companies that are categorized as growth companies, it will all make sense. These indicators may lead all signs to newer companies. But remember, this isn’t always the case.
Growth Companies Examples
Look at Amazon and Netflix. They came into their industry with complete game changing ideas. They were introducing some innovative product/service/technique into doing business. This product or service or technique was created by them because they believed it would have significant impact on the business in the future. Well, I think the creators of Netflix and Amazon were correct with their competitive advantage as we are now seeing disruption they are doing to their respective industries.
The way Netflix operates is now making others in that industry pivot and adjust to compete with Netflix. The only way other content providers are competing with Netflix (as of right now), is to essentially do what Netflix does. TV service providers are more uncomfortable than ever. People are leaning more towards cutting their cable and subscribing to a select few content providers similar to Netflix for monthly fees. Which by the way, monthly fees are extremely cheaper than the typical TV, Phone and Internet provider.
Now I hope with that insight into Netflix can help give you a better understanding of a growth company compared to a value company. Now obviously you can’t just look at a company and categorize them whether they are a growth or value company by determining how quickly they have grown or if their product/service/technique is “futuristic” or industry disrupting. You need to consider other characteristics that tend to be true when determining a value or growth stock.
There are a few characteristics most growth stocks will have.
- Growth stocks don’t usually pay a dividend
- Growth stocks will typically have a very loyal customer base
- Growth stocks will have a unique product or service offering
This is just a list of some other indicators to keep an eye out for. As you are probably starting to see, the key indicator will be some unique product or service offering that has not yet been established by any other players in that particular industry.
You want to also consider some questions to ask yourself when evaluating these companies.
- How much are you willing to pay for this growth stock?
- Will this company keep growing or has it reached its peak of above average performance compared to peers?
- What is the PE Ratio?
A company’s PE Ratio is a key indicator for determining if it is a growth or value stock. Growth stocks tend to have a very high PE compared to a value stock. Value stocks you will typically see a 10x or 15x PE. A growth stock will be much higher, something around 100X or higher.
Portfolios should often hold a combination of both growth and value investments.