Investing.com — Growth stocks are considered shares of a company that are expected to grow significantly faster than the market average.
But in a note to clients this week, Bernstein analysts laid out a more expansive definition of these stocks.
“Growth stocks typically generate higher and more consistent revenues and are more profitable than the average company. We look for recognition of these qualities in the market through premium valuation ratios,” they wrote.
One of the biggest hallmarks of a growth stock is its valuation, the Bernstein analysts noted, adding that companies that can “produce superior growth rates tend to be well known and priced accordingly.” Today, growth stocks sell at 1.4 times the market average, they said.
Another fundamental aspect of Bernstein’s growth stock definition is performance. Growth stocks have outperformed value stocks (or stocks considered to be trading below fundamental levels) in recent quarters, although that trend ended in the third quarter of this year, the analysts said.
Growth names are also “stocks with high premiums and high expectations,” the analysts argued, adding that “the penalties for disappointment are high, and producing high growth rates over long periods of time is difficult.”
“[G]The argument becomes more difficult as companies get bigger. Only 6% of companies with revenues over $25 billion have managed to grow revenues by more than 15% over the past decade, compared to 14% of companies with revenues over $1 billion.”
Metrics such as price momentum and three-year consensus earnings growth forecasts also “work best in the expansion phase of the business cycle,” the analysts said. Historical growth sectors also tend to perform better when bond yields are lower, they reasoned.
To determine a growth stock, Bernstein analysts said they consider these seven factors: five-year revenue growth relative to the market, revenue growth stability, reinvestment rate, relative forward price-to-earnings ratio, relative forward price-to-earnings ratio, relative price -earnings ratio. book value and relative price-sales.
Based on this definition, their analysis found that 74% of the current growth universe, as measured by equity shares, consists of technology, consumer discretionary, healthcare and industrials. Measured by market capitalization share, the growth universe consists of 41% technology, 13% consumer discretionary and 11% communications services.
By region, emerging markets and Asia tend to have much higher long-term growth compared to developed markets such as the US, the analysts said. China and India have historically been the highest long-term growth markets, averaging 12% and 15% respectively, although these current levels have moderated.
