What Is a Growth Company?
Let me explain what a growth company is. It's any company where the business generates significant positive cash flows or earnings that increase at rates much faster than the overall economy. You should know that these companies often have very profitable ways to reinvest their own retained earnings. That's why they usually pay little to no dividends to stockholders—instead, they put most or all of their profits back into expanding the business.
Understanding a Growth Company
Growth companies have really defined the technology industry. Take Google as the classic example—since its IPO, it has massively grown its revenues, cash flows, and earnings. I want you to understand that growth companies, sometimes called gazelles, are expected to boost their revenues and profits significantly in the future. This is why the market pushes their share prices to high valuations.
This is different from mature companies, like utility firms, which report stable earnings with little to no growth. Growth companies create value by expanding above-average earnings, free cash flow, and spending on research and development. As an investor, you might not worry about dividend growth, high price-to-earnings ratios, or high price-to-book ratios in these companies because the focus is on sales growth and staying ahead in the industry. Overall, growth stocks pay lower dividends than value stocks since profits go back into the business to drive earnings growth.
Growth Companies During Bull and Bear Markets
During bull markets, you see growth stocks being preferred and often outperforming value stocks due to lower perceived risks in a strong environment. However, in bear markets, growth stocks tend to underperform value stocks because weak economic activity slows down sales growth and the momentum that drives these stocks higher.
Mature companies handle bear markets better than growth companies. They're deeply rooted in their industries, have loyal customers, are well-known, and possess stronger financials like larger cash reserves to weather tough times. Also, mature companies find it easier to raise capital during economic difficulties because they're established with proven credit. Growth companies, with their less established financials, might struggle to get loans, so they often turn to venture capital firms or angel investors. This extra capital can be crucial for some growth companies to survive downturns.
Real World Examples
Most growth companies are in the technology sector, where rapid innovation and heavy spending on growth are the norm. Consider Google (GOOGL), Tesla (TSLA), and Amazon (AMZN) as prime examples—they keep investing in innovative technologies, sales growth, and new business expansions.
Even though these stocks have valuations higher than the S&P 500, they're leaders in their fields. Google is building its tech conglomerate status by moving into areas like artificial intelligence. Tesla leads the electric car industry without question. Amazon keeps disrupting retail through its e-commerce platform, pulling business from traditional stores. These stories attract investors who expect continued growth.
That said, these companies are now quite established in their industries and make solid investments, different from their early days as small startups. Growth companies aren't just in tech—take Etsy (ETSY), the e-commerce platform for vintage and craft items, as an example in another sector.
Key Takeaways
- A growth company generates positive cash flows or earnings faster than the overall economy.
- These companies reinvest earnings back into the business instead of paying dividends to spur further growth.
- They contrast with mature companies that have stable earnings and little growth.
- Mature companies obtain financing more easily due to their established status.
- Investors in growth companies focus on share price appreciation rather than dividends.
- The technology sector features many growth companies today.
