Your guide to investing in growth stocks (2024)

If you’re above average, you have something in common with many of the world’s public companies. Simply put, growth stocks are stocks in companies expected to increase their revenues at a rate higher than the market average.

As with many areas of investing, there’s nuance among growth stocks, particularly as you attempt to create a diversified portfolio.

Understanding growth stocks

In the most straightforward terms, growth stocks are not only growing revenues at a faster-than-average pace, they also typically reinvest those revenues into their businesses to spur future growth.

While profits matter, they’re not always at the forefront when investors evaluate growth stocks. High-growth companies are not always profitable as they tend to aggressively invest in growing the business.

Because they operate in this relatively aggressive business cycle, high-growth companies tend not to pay dividends. Rather than return cash to shareholders this way, they tend to reinvest it. However, this is not always the case. Dividend-paying growth stocks do exist. This is where some of the aforementioned nuance comes into play.

A good way to wrap your head around growth stocks is to consider the so-called “Magnificent Seven,” a group of large-cap growth stocks that includes Microsoft, Apple, Alphabet (parent company of Google), Amazon, Nvidia, Meta Platforms (parent company of Facebook) and Tesla.

As Russell Investments explains, “Investors have flocked en masse to the Magnificent Seven stocks in recent years not only for their attractive expected long-term growth profiles, but also for their potential protection from the erosion of purchasing power due to inflation. This broad appeal has driven significant outperformance for those stocks over time; that was again the case in 2023 and continues so far in 2024.”

However, not all of the Magnificent Seven stocks are, technically, growth stocks at the moment. And some that actually are growth stocks happen to pay dividends.

We’ll use the to illustrate, as it is a common market gauge or benchmark. According to FactSet, the average revenue growth rate, across sectors, of the S&P 500 stocks was 4% in the fourth quarter of 2023. The sector where most of the Magnificent Seven stocks sit — information technology — experienced an above-average growth rate (7.1%), as did other spaces, including health care and financial stocks.

Of the Magnificent Seven stocks, Apple and Tesla have growth rates that trail the S&P 500 average. Four stocks pay dividends, including three with robust revenue growth rates. While these stocks don’t speak for the entire S&P 500 or larger universe of stocks, they were responsible for 62% of the S&P 500’s gains in 2023, based on stock price appreciation. They’re a necessary part of any modern-day growth stock discussion.

Some key points

There’s often debate around how to classify growth stocks. That debate rages with Apple, but less so with Tesla, which most analysts see as experiencing a slowdown in growth that might or might not persist over the long haul. Morningstar argues that Apple can be both growth and value, depending on your methodology, with the stock tending toward growth on some metrics and not so much on others.

Based on the numbers, you can’t argue that Meta, Nvidia and Microsoft, which all pay dividends, aren’t growth stocks. They’re just at different stages of growth and pay different types of dividends, as measured by the size and growth of the dividend payment.

You can perform this same exercise with S&P 500 (and other) stocks outside of the Magnificent Seven.

For example, we ran a screen of S&P 500 stocks, limiting the results to dividend-payers with annual revenue growth of 25% or more over the last five years (much higher than the S&P 500 average of 6.9%), and it returned 16 companies. Only one, Nvidia, is part of the Magnificent Seven. Broaden the parameters beyond the S&P 500, and the screen returns nearly 250 stocks that meet the high-growth/dividend-payer criteria.

This said, a majority of growth stocks do not pay dividends, as evidenced by the following list of the 10 S&P 500 stocks with the greatest annual revenue growth over the past five years, as of March 2024. Only three of these companies (NRG Energy, Coterra Energy and Cigna) pay a dividend.

If you add expected earnings-per-share (EPS) growth of 25% or higher over the next five years, the screen returns some of the same and a couple of other growth stock names. While some investors don’t emphasize profits (what’s left over from revenue after all expenses are accounted for) when looking at growth within the context of growth stocks, profitability alongside significant revenue growth can signal that a company operates from a meaningful position of strength now and for the foreseeable future.

Growth versus value stocks: A comparison

To better understand whether growth stocks are right for your portfolio, it helps to compare growth versus value stocks.

Fidelity Investments defines value stocks as “companies whose stock prices don’t necessarily reflect their fundamental worth,” reflected in “bargain” share prices that will eventually come into line with a company’s fundamentals, triggering an increase in the price of a company’s stock.

Generally, growth stocks are more expensive, as investors value them based on above-average past and, more so, future growth. However, they’re also riskier, particularly because if a growth stock doesn’t meet lofty expectations, the share price often drops considerably.

When a company doesn’t meet expectations, a decrease in its stock price could be temporary (especially if the originally anticipated growth returns) or persist in the long term. This makes growth stocks typically more volatile than value stocks, which, as Fidelity points out, are less expensive and less risky because “They have already proven an ability to generate profits based on a proven business model.” This definition alone shows why some stocks, such as Apple, straddle the line between the growth and value classifications.

How to buy growth stocks

To buy growth stocks, there are a few simple steps investors should follow.

1. Consult a financial advisor: First, it’s a good idea to consult a financial advisor before you start buying growth stocks. An advisor can assess your current financial situation and help determine whether growth stocks are right for your portfolio.
2. Open a brokerage account: The next step is to open a brokerage account, retirement account, or a combination of both. Some retirement accounts, such as 401(k) plans, are available through your employer, while brokerage and other retirement accounts, like traditional and Roth IRAs, can be opened by individual investors with just a bit of paperwork.
3. Choose growth investments: Finally, you’ll need to determine if you want to purchase individual growth stocks or get exposure to growth stocks via exchange-traded funds (ETFs) or, in some cases, mutual funds.

Benefits and risks of investing in growth stocks

One of the biggest benefits of buying growth stocks is that they “can provide great returns,” but you must balance this potential upside with inherently “higher risk,” said Daniel Razvi, senior partner and COO at Higher Ground Financial Group.

W. Cole Christian, a certified public accountant (CPA), certified financial planner (CFP) andsenior wealth advisor and director of Investments at Hightower Wealth Advisors in St. Louis, explained that “buying ETFs makes a lot of sense” because investors can spread their risk across hundreds, even thousands, of companies through an ETF.”

Christian argued that, based on “clear” research, trying to be an individual stock picker “is a low-probability endeavor.” Therefore, he favors the broad exposure that ETFs provide.

“The type of ETFs to invest in will depend on the client’s goals and risk profile,” he said. “Luckily, there are plentiful ETFs to choose from, so gaining diversifying exposures cheaply has become simple to do.”

Nicholas Yeomans, a CFP and president of Yeomans Consulting Group, agreed: “While owning individual brand name companies can feel good, especially when performing well … you are also taking on risks that might be unnecessary. These risks include company risk, sector risk and market risk. While owning great companies can be rewarding, you have to look at your goals and objectives, as well as risk tolerance. For many investors, you can move closer to your goals with a risk-adjusted portfolio … [of] ETFs. This can reduce your company risk and sector risk while still moving you in the right direction.”

All of this begs the question: What type of ETF makes sense for you? Of course, there’s no one-size-fits-all answer. However, we can have a general discussion around desired growth stock concentration, particularly via ETF investing.

Key factors to consider before buying growth stocks

To answer this question, you have to balance the risk inherent with growth stocks alongside potential reward and the individual-stock-versus-ETF approach.

Razvi summed it up like this: “If all your money is in one or two companies and their stock crashes, you could be wiped out. ETFs (as long as they are very low-fee) can be more diversified because they invest in many different stocks, but since it is still all ‘opinion-based assets’ (valuation based on market opinion rather than a contractual guarantee) there is still a big risk of loss. The closer you get to retirement, the more important it is to preserve what you have rather than to potentially grow. If you know you can never lose money, the necessary returns are much smaller because you don’t have to overcome a big loss.”

Ultimately, when assessing growth stocks, you must consider:

• Past growth
• If any decrease in growth (like with Apple and Tesla) is only temporary
• Future growth prospects, which, as Razvi pointed out, is as much about opinion as objective fundamentals

For some investors, it makes sense to go with a best-of-both-worlds approach. Blended ETFs favor neither growth nor value, often using a strategy known as “growth at a reasonable price” (GARP), which according to Morgan Stanley, seeks stocks with strong growth potential that aren’t overvalued.”

So the answer to the question starts with your personal risk assessment and might end with a hybrid balance between the two investing styles.