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.
Understanding Growth Company
Growth companies have characterized the technology industries. The quintessential example of a growth company is Google, which has grown revenues, cash flows, and earnings substantially since its initial public offering (IPO). Growth companies such as Google are expected to increase their profits markedly in the future; thus, the market bids up their share prices to high valuations. This contrasts with mature companies, such as utility companies, which tend to report stable earnings with little to no growth.
Growth companies create value by continuing to expand above-average earnings, free cash flow, and spending on research and development. 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 the focus is on sales growth and maintaining industry leadership. Overall, growth stocks pay lower dividends than value stocks because profits are reinvested in the business to drive 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 environmental risk and the perceived low risk in the markets. However, growth stocks tend to underperform value stocks during bear markets because weak economic activity hinders sales growth and the growth engine that drives 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 typical. Google, Tesla, and Amazon are three classic examples of growth companies because they continue to focus on investing in innovative technologies, sales growth, and expansion into new 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 industry. Meanwhile, Amazon continues to disrupt the retail sector through its ecommerce platform, which takes away business from traditional brick-and-mortar retail competitors.