Many investors aim to outperform the market and reach their financial goals sooner than people who invest in the S&P 500. These same investors often gravitate toward growth stocks. Assets in this category come with more risk, but they can also deliver more upside. 

Some people trade growth stocks because they have more volatility, while others hold onto them for the long run. However, you have to know the hallmarks of a growth stock before you get started. Knowing what these stocks are and some strategies to boost your returns can help you reach your financial goals sooner.

The Common Characteristics of Growth Stocks

Growth stocks exhibit high revenue and net income growth rates while operating in promising sectors. While profitability isn’t a requirement to be counted as a growth stock, investors expect to see narrowing losses from companies that have not yet produced net profits.

Some of these stocks generate regular media exposure. The Magnificent Seven stocks are the best example of growth stocks that attract plenty of investors. However, there are also smaller stocks with market caps below $10 billion that are silently outperforming the market.

Growth stocks produce double-digit year-over-year revenue growth. Some investors treat 10% revenue growth as a growth stock, while others prefer growth rates that are above 20%. 

How to Find Undervalued Growth Stocks

It isn’t enough to find growth stocks that have good financials. Reviewing a stock’s valuation and long-term trends can help you gauge if you have stumbled across an undervalued growth stock. These investments are optimal since they offer a margin of safety while presenting growth prospects.

Investors can use several metrics and ratios when assessing the fair value of a stock. The P/E ratio is one of the most recognized ratios, but it doesn’t do enough justice for growth stocks. The issue with growth stocks is that they usually command high valuations since investors focus on what these stocks can become. 

The forward P/E ratio is a more useful ratio for investors. It tells you about a stock’s valuation based on its anticipated earnings. This key difference favors companies with high P/E ratios that are poised to grow their profits significantly in the upcoming year.

A good forward P/E ratio depends on the stock’s sector. You can’t compare a bank stock’s P/E ratio with a tech stock’s P/E ratio since investors have different expectations for those assets. 

The best way to find undervalued growth stocks is to use stock screeners. You can filter results based on financial growth rates, valuation metrics, and other details. These are some of the stock screener filters you can use to find undervalued growth stocks:

• 15%+ year-over-year revenue growth
• 15%+ gross profit margin
• 15%+ year-over-year EPS growth
• Forward P/E ratio under 50

These are some inputs you can use for your first stock screener. Investors can get more detailed with stock screeners to find competing opportunities. For instance, you can use these same inputs and also filter results to show stocks that have dropped by more than 20% over the past six months. Some of those drops may be overreactions that have set up buying opportunities.

Are Growth Stocks Risky?

Growth stocks have the potential to outperform the S&P 500, but those returns aren’t free. These stocks rally the most during bull markets but can also suffer sharp drawbacks during market corrections. Investors can mitigate the risk of growth stocks by diversifying their portfolios and looking for growth stocks with lower valuations.

Any investment has risks, and even a boring stock that has been stable for many years can suddenly drop. Any macroeconomic news or company-specific updates can create significant price fluctuations for growth stocks.

Growth Stocks vs. Value Stocks

Growth stocks continue to gain market share in their industries and attract more attention from investors who want to beat the market. These assets can significantly outperform value stocks but are riskier. 

Value stocks are mature companies that don’t have as many growth prospects. These companies may generate low or mid-single-digit year-over-year revenue and net income growth. However, they are reliable companies that have withstood various economic cycles for decades. These same stocks are usually less volatile than the broader market and have higher yields. Value stocks can still do well, but the focus centers around a low P/E ratio, moderate growth, and stability.