In the investing community, never has there been a term more misunderstood than growth stock. To many, a growth stock simply means a name stock or a stock with a lot of demand. To others, it is just one of the stocks selling at high earnings multiples.
Being "name" or popular is not necessarily synonymous with true growth. More often than not it is a stock that has already seen its growth. You are not likely to make money with a stock that has already made a lot for others.
Whenever speculative fever runs high, investors tend to overreach for popular stocks. One widely held misconception, especially in periods of market excesses, is that growth stocks constitute a sort of different species and are, therefore, somewhat above reasonable price-earnings ratios, which are generally accepted as the basic criteria for stock prices.
That, of course, is absurd. Whether it's growth or nongrowth, the all-important price-earnings ratio should always be the predominant determinant of stock prices. Even allowing for its admittedly greater growth potential, a growth stock should still be evaluated primarily on the same basis of earnings or at least earnings potential. No stock, growth or nongrowth, is above earnings. A few exceptional stocks do merit a high price despite their lack of current earnings. Inexperienced investors, however, would do well to stay away from such issues or situations.
No place else could neophytes get hurt so easily as in the stock market. In their reach for a fast buck, many have come to discard the first investment safeguards and, in the words of Keith Funston, president of the New York Stock Exchange, were "feverishly substituting rumor, hearsay and a desire to get rich quick for sound investment judgment."
This danger is real when people put money into stocks before trying to find out the first thing about the underlying companies. Nobody in the market for a house would buy a home without first checking it out. It seems a little odd for usually cost-conscious Americans to buy several thousand dollars worth of stock without even taking a look at the company's record.
The growth stock concept is well entrenched, with the great majority of investors long having recognized growth stocks as a major type of investment opportunity. Everybody loves a true growth stock. Other things being equal, a growth stock is definitely preferred to a nongrowth stock. Generally, you are expected to pay some premium for a growth stock. The important think is not to overpay for it. Also, you should subject a growth stock to the same rigid standards of scrutiny as you would any other stock you buy.
Nothing but the most exceptional cases should induce you to buy into companies without a solid record of growth. Avoid companies that are largely based on expectations or "projected" growth. Even a good record of growth in the past is not necessarily indicative of its future trend.
Still, basic data is important. Perhaps the single most revealing and surest yardstick of industry or corporate growth is profit margin. A widening profit margin always means better cost control, lower production costs and
other management features, which are classic characteristics of a growth company.
This and other "fundamentals" about a company or industry are what make a situation basically attractive. Beginners would do well to get involved only with situations sound in "fundamentals," though a brilliantly timed purchase of even a basically unattractive stock might work out well.