What are growth stocks? When we talk of growth stocks, what do we mean? What type of stocks are we talking about? You must have often heard these phrases from the mouths of analyst or commentators on CNBC like large cap, mid cap, small cal, growth, value.
So let's define what these terms mean.
Capitalization or cap means the overall market value of the outstanding shares of a company's stock.
Large cap means a company whose market capitalization is in excess of $5 Billion.
Mid cap means a company whose market capitalization is between $1 to $5 Billion and a small cap company is one whose market capitalization is between $1 Billion and $250 million.
Smaller than $250 million and we can say micro cap.
Now these divisions are often blurred and rough but still help in quantifying what a large cap and a small cap can be.
In order to understand a growths stock, we will have to understand the term Price to Earnings Ratio (P/E).
P/E ratio is also an often quoted term that you might have come across.
P/E ratio is obtained by dividing the current price of the stock with the earnings per share of the company for the last year.
Suppose company ABC stock is selling at $50 right now and it's earnings per share for the last year were $5.
So its P/E ratio would be 50/5=10.
High P/E ratio stocks are considered to be growth stocks and low P/E ration shares are considered to be value stocks.
All the time you will be hearing headline news about the growth potential of company on CNBC, Financial Times, Wall Street Journal and Bloomberg.
In other words, most of the headlines go to the growth stocks.
  Are growth stock really good investments? Eugene Fama in early 1970s had done seminal research on stocks and stock markets.
His research broke many myths about stocks and stock markets.
One of the myths that he broke was that in the last 77 years, the annualized return of growth stocks have been only 9.
9% as compared to 11.
5 % for the value stocks.
Now you must be wondering what can be the reason for the poor performance of growths stocks.
The most common sense reason is that these stocks get too much publicity and become highly popular with the investors.
This makes them overpriced.
So when you buy a growth stock, it is already overpriced.
Hence their poor return overtime.
The best strategy is to build a portfolio of stocks diversified between large cap, mid cap, small cap, value and growth stocks.